Profiting from volatile markets

Published October 15, 2011


Derivative trading platforms report robust growth as more people seem to have taken to trading currencies and other derivative contracts. By Genevieve Cua


ELEVATED market volatility is a source of anxiety for many, but for others it's a chance to take a stab at some outsized profits - or losses.


Whichever way it plays out for clients, derivative trading platforms such as IG Markets report robust growth as more individuals appear to have taken to trading currencies and other derivative contracts such as equity indices and commodities.

IG Markets, for instance, reports a record month globally in August when volatility shot up on the US downgrade and on concerns over Greece. Says Tim Howkins, IG Group chief executive: 'It's the rate of change of volatility that affects client behaviour . . . The client base reacts immediately to an uplift in volatility, but progressively they get used to the new levels. We had by far the best August we've ever had; it was 82 per cent higher than August last year.'

In August, the VIX index (which reflects the volatility of the S&P 500) spiked to a high of 48 from a level of around 17 in July. The S&P 500 fell more than 15 per cent between July and mid-August and gyrated sharply within a trading band that month. August saw four straight days of 400-point swings in the Dow Jones index.

Grace Chan, Phillip Futures' director of marketing and sales channel, says trading volume between July and September 'definitely increased'. She points to a record high volume in the Loco London spot gold contracts. Gold prices posted a record 18.9 per cent rise from a US$1,607 per ounce low in August to US$1,912.

In its first-quarter results (June 1 to Sept 12), IG Group Holdings reported a 20 per cent increase in active clients and 8 per cent rise in revenue per client. In terms of revenue, Asia Pacific (lumped into the 'rest of the world' segment) jumped 79 per cent, albeit off a low base. Revenues rose from £4 million to £7.2 million (S$14.5 million). The main contributor was Singapore, which saw a 61 per cent rise in revenue per client, with active client numbers up 3 per cent.

That growth was achieved in spite of a clampdown on the use of 'introducers' or referrals as a source of new clients. In the aftermath of the Lehman notes debacle, the Monetary Authority of Singapore (MAS) restricted the use of introducers to 'induce' clients to invest. Under the guideline, introducers who try to persuade clients to subscribe for securities will be subject to licensing. Introducers who earn commissions based on the volume of transactions of clients may be deemed to be dealing in securities.

Peter McDermott, IG Singapore managing director, said the restrictions which took effect last year caused new account openings to fall 55 per cent. 'That's quite a big blow, but we still managed to grow revenues 38 per cent.' The firm strives to target its services at the high net worth market.

'A year-and-a-half before the rule change, we changed strategy to aim for wealthier clients. We do not want inappropriate clients - it's not good for us or for clients.'

There are a number of derivative broker dealers here licensed by MAS. Those that have a retail business include IG Asia, Saxo Capital Markets, Phillip Futures and optionsXpress. Market share is understood to be fragmented. The platforms offer educational seminars, many of which are free.

The largest provider may well be Phillip, which claims to have pioneered the offering of an online FX (foreign exchange) and CFD (contract for difference) trading platform. Says Ms Chow: 'In 2010 we commissioned an independent external survey company to do a study of our market share in the local market . . . we have the largest share in terms of clients holding an account with us to trade FX and CFDs.'

There are also online platforms that are offshore, but clients will have to bear in mind that there will be little or no recourse to MAS should there be disputes or lapses in service.

Typically the amount needed to start an account is modest at less than $5,000, but it will depend on the initial margins required for a particular contract.

Derivative contracts are a form of leveraged trading. The initial margin may be set at 10 or 20 per cent. There are other costs involved such as commissions and financing charges. Leverage magnifies profits, but can also cause substantial losses on the downside. Apart from the risk of leverage, there are also counterparty risks. Clients should ascertain that the broker they use is well capitalised.

Do clients actually make money? Mr McDermott says yes. 'There is definitely a learning curve. The longer established clients tend to be successful, and newer clients less so. It takes a while to get your risk management right . . .

'We hedge the vast majority of client trades, and it's in our interest for our clients to make money. We make money from dealing commissions, spreads and overnight financing. The more clients deal, the better for us. It's not good for us if they lose their money.'

IG does not run any proprietary trading desk. Phillip does have a 'small' prop desk. Says Ms Chan: 'The prop positions we run are more for hedging or to test out certain strategies. We take very small positions.'

So what makes a successful trader? Money and risk management discipline is key.

Mr Howkins says: 'The thing is not to put too much capital into your first trade, or into any trade . . . Go slowly, use stops, risk management and guaranteed stops.' The latter means the broker guarantees to close your position at a pre-specified price, for a one-off charge. This enables a trader to know his maximum possible loss at the outset.

You will also have to set your objectives and follow your plan. This minimises the chance that you are swayed by emotion. Ms Chan says: 'Good traders often set an appropriate risk-reward ratio for each trade they enter. No one can be right in every trade, but good risk management and discipline can help ensure that losses are controlled and profits are consistent.'

She adds that successful traders also have a good understanding of their own risk appetite, trading style and personality. 'What works for one may not work for another. So to be consistently profitable, one needs to find one's own trading edge or technique . . . '