Published September 2, 2010
By R SIVANITHY
AS REPORTED in this column some weeks back ('How well do investors understand CFD risks?' BT, July 22), regulatory antennae in Australia were recently raised when the authorities found from a survey that a large number of retail players in the contracts for differences (CFD) market were ignorant of the risks associated with the instrument.
A study was then launched by the regulators and it remains to be seen what measures, if any, the authorities Down Under will impose on the CFD industry to address the concerns the survey raised.
It also remains to be seen if the situation is similar in Singapore, where CFDs are said to be one of the fastest-growing segments in the local financial market.
Leverage effect
Until any such survey is conducted, though, there are nevertheless several points of interest that prospective and current CFD investors might wish to consider when dealing with this instrument.
First and most obvious is to gain a thorough understanding of all the facets of CFDs and the leverage effect they can offer via the margin feature - both on the upside and downside.
In this regard, it's worth noting the commissions to be paid and the interest or funding charges for long positions. (Conversely, note that interest is earned for short positions).
Second is to compare the features of CFDs with other leveraged products such as structured warrants before deciding which instrument is best for individual needs.
For example, warrants have a short-term, finite lifespan and require knowledge of how volatility works but are traded on the Singapore Exchange (SGX), whereas CFDs theoretically have an unlimited lifespan and need not require volatility calculations but are not - at least not yet, in Singapore's case - traded on SGX.
Third and perhaps most importantly, once the investor has decided to take the CFD plunge, is to select an appropriate CFD provider. This is the counterparty in a CFD trade - the financial entity with whom the CFD account is opened - and so this means it is vital to ask certain questions before setting up an account and commencing trading.
First, it's best to scrutinise the account-opening forms to see if the provider highlights the risks associated with CFDs or relegates these to the fine print. This might offer clues as to how the provider conducts its business and whether it is a long-term player who wishes to forge a lasting relationship with clients or otherwise.
Second, education and training, without which it would be impossible to trade CFDs meaningfully. In Australia's experience mentioned earlier, the survey found that in some cases, even sales personnel themselves were not fully conversant with the intricacies of CFDs.
In this regard, it would be worthwhile checking if the provider invests meaningful resources training and educating all its customers - and staff. Again, this would provide some indication as to its long-term commitment to its business.
Third, it's worth finding out if the provider force-sells clients' losing positions if these positions become under-margined, to prevent such clients from losing too much money.
In CFD trading, the effect of leverage means that losses can be hugely magnified and thus not confined to the initial capital outlay (which typically is just a fraction of the price of the underlying assets). If positions are not monitored constantly or if markets 'gap' unexpectedly (that is, open with an unnaturally large gap between current and most recent prices), the consequent loss can be painfully large if not closed out quickly.
Financial strength
Providers are, of course, under no obligation to exercise discretion and close out losing positions, but some are known to take the initiative and try to limit a customer's loss by acting of their own accord.
Finally, the provider's financial strength. Just like trading in any instrument, there is a risk of loss connected to the financial standing of the broker/ bank/warrant issuer/CFD provider that is providing the service.
Prospective customers should therefore perform their own 'due diligence' on the provider's background before signing on the dotted line.
Finally, note that CFDs are not for everyone. They are inherently riskier than ordinary stocks and so require a greater degree of sophistication when trading.
They are, however, a useful addition to any financial market since their presence enhances the range of products available to investors. The key, as always, is education, understanding and knowing the right questions to ask.
Showing posts with label CFD. Show all posts
Showing posts with label CFD. Show all posts
Thursday, September 2, 2010
Thursday, July 22, 2010
How well do investors understand CFD risks?
Business Times - 22 Jul 2010
By R SIVANITHY
ANECDOTAL evidence suggests that the market for contracts for differences (CFDs) has grown strongly over the past few years and shows no signs of slowing down. No one knows just how big the local market is, since these instruments are traded over the counter (OTC).
But thanks to aggressive advertising and marketing by the big CFD players, an increasing number of retail investors are known to be trying their luck in the CFD arena, probably also encouraged by the fact that several local brokers have also jumped on the CFD bandwagon.
This is fine - the more financial instruments there are available to the investing public, the better. But CFDs are highly complex instruments with plenty of inherent risk.
With a currency CFD for example, it is possible to enjoy 100 times leverage, an attractively high number if the market moves in the investor's favour. But what is sometimes forgotten in sales pitches is that the knife cuts both ways.
So you have to wonder: Are retail players fully informed of all the risks? Or is the financial industry's approach the same as it was on the sale of the failed structured products such as Lehman Minibonds - that is, to focus almost exclusively on high potential returns and downplay the high risks?
You also have to ask, for example, why it is that CFDs are not allowed to be sold to retail investors in the US. And why it is that in the UK, retail investors have to take a suitability test before being allowed to trade CFDs?
Australia has, until now, had no major restrictions on CFDs. But last week, the Australian Securities and Investments Commission (ASIC) - the country's corporate regulator - said that it was looking to clamp down on the CFD industry because of widespread ignorance of the risks.
Ignorant of dangers
The Australian Financial Review, in its July 12 edition, quoted ASIC commissioner Greg Medcraft as saying: 'People just don't understand how dangerous (CFDs) are. There is a real lack of understanding about the impact of leveraging and how it can devastate them.
It's actually riskier than going to the bookies, because with bookies, if you put down $10,000 you only lose $10,000. Here, you put down $10,000 and you've lost your house and whole life savings.'
In the course of its investigations into the Aussie CFD market - estimated to be A$350 million last year but thought to be much larger today - ASIC found that investors were not only ignorant of the risks involved, but also were not being warned by those selling CFDs because the sellers themselves did not fully understand the risks.
It was also reported that two market makers or providers - CMC Markets and IG Markets - control around 70 per cent of the market.
Should the Monetary Authority of Singapore conduct a similar survey here to see if the burgeoning number of investors in CFDs really know what they are buying into? The answer, judging by the experience Down Under, is why not?
Questions to ask
If there was to be such a review - apart from the obvious questions about understanding how leverage works - investors should be asked if they understand the exact nature of the product. For instance, that when they take a CFD position, it is the market maker who is on the opposite side of the trade, which means the playing field is slightly tilted in favour of the market maker because it knows what its customers' positions are and can hedge itself accordingly - usually in the underlying cash market.
The investor has no such knowledge. Nor does he know what positions the house has taken, so even though some people may think this is insignificant, there is nevertheless asymmetric information in a CFD trade.
Similarly, do investors realise that unlike margin loans, CFD positions are not closed - or force-sold - when the market moves against them, which in theory could mean potentially large losses if the position is not constantly monitored and/or if no stop-loss is implemented?
Additionally, do investors realise that holders of CFDs on stocks are not entitled to dividends, because CFDs are not shares? Do they know that unless they have some form of deposit insurance, there is a chance - albeit small - that they could lose all their money if the market maker goes bust?
Also worth asking is if whether the deposit money collected from opening a CFD account is placed into a pooled segregated account and if so, how this money is to be used if very large customers incur big losses and cannot pay up?
As stated earlier, this is not to say that CFDs are unsuitable investments for retail players. But clearly, these instruments, given their risky nature, are not suitable for everyone. Going by the experience of other developed markets - the latest being Australia - it is worthwhile for local regulators to check if there is adequate disclosure in the marketing of CFDs here.
Copyright@2010 Singapore Press Holdings Ltd. All rights reserved.
By R SIVANITHY
ANECDOTAL evidence suggests that the market for contracts for differences (CFDs) has grown strongly over the past few years and shows no signs of slowing down. No one knows just how big the local market is, since these instruments are traded over the counter (OTC).
But thanks to aggressive advertising and marketing by the big CFD players, an increasing number of retail investors are known to be trying their luck in the CFD arena, probably also encouraged by the fact that several local brokers have also jumped on the CFD bandwagon.
This is fine - the more financial instruments there are available to the investing public, the better. But CFDs are highly complex instruments with plenty of inherent risk.
With a currency CFD for example, it is possible to enjoy 100 times leverage, an attractively high number if the market moves in the investor's favour. But what is sometimes forgotten in sales pitches is that the knife cuts both ways.
So you have to wonder: Are retail players fully informed of all the risks? Or is the financial industry's approach the same as it was on the sale of the failed structured products such as Lehman Minibonds - that is, to focus almost exclusively on high potential returns and downplay the high risks?
You also have to ask, for example, why it is that CFDs are not allowed to be sold to retail investors in the US. And why it is that in the UK, retail investors have to take a suitability test before being allowed to trade CFDs?
Australia has, until now, had no major restrictions on CFDs. But last week, the Australian Securities and Investments Commission (ASIC) - the country's corporate regulator - said that it was looking to clamp down on the CFD industry because of widespread ignorance of the risks.
Ignorant of dangers
The Australian Financial Review, in its July 12 edition, quoted ASIC commissioner Greg Medcraft as saying: 'People just don't understand how dangerous (CFDs) are. There is a real lack of understanding about the impact of leveraging and how it can devastate them.
It's actually riskier than going to the bookies, because with bookies, if you put down $10,000 you only lose $10,000. Here, you put down $10,000 and you've lost your house and whole life savings.'
In the course of its investigations into the Aussie CFD market - estimated to be A$350 million last year but thought to be much larger today - ASIC found that investors were not only ignorant of the risks involved, but also were not being warned by those selling CFDs because the sellers themselves did not fully understand the risks.
It was also reported that two market makers or providers - CMC Markets and IG Markets - control around 70 per cent of the market.
Should the Monetary Authority of Singapore conduct a similar survey here to see if the burgeoning number of investors in CFDs really know what they are buying into? The answer, judging by the experience Down Under, is why not?
Questions to ask
If there was to be such a review - apart from the obvious questions about understanding how leverage works - investors should be asked if they understand the exact nature of the product. For instance, that when they take a CFD position, it is the market maker who is on the opposite side of the trade, which means the playing field is slightly tilted in favour of the market maker because it knows what its customers' positions are and can hedge itself accordingly - usually in the underlying cash market.
The investor has no such knowledge. Nor does he know what positions the house has taken, so even though some people may think this is insignificant, there is nevertheless asymmetric information in a CFD trade.
Similarly, do investors realise that unlike margin loans, CFD positions are not closed - or force-sold - when the market moves against them, which in theory could mean potentially large losses if the position is not constantly monitored and/or if no stop-loss is implemented?
Additionally, do investors realise that holders of CFDs on stocks are not entitled to dividends, because CFDs are not shares? Do they know that unless they have some form of deposit insurance, there is a chance - albeit small - that they could lose all their money if the market maker goes bust?
Also worth asking is if whether the deposit money collected from opening a CFD account is placed into a pooled segregated account and if so, how this money is to be used if very large customers incur big losses and cannot pay up?
As stated earlier, this is not to say that CFDs are unsuitable investments for retail players. But clearly, these instruments, given their risky nature, are not suitable for everyone. Going by the experience of other developed markets - the latest being Australia - it is worthwhile for local regulators to check if there is adequate disclosure in the marketing of CFDs here.
Copyright@2010 Singapore Press Holdings Ltd. All rights reserved.
Wednesday, May 13, 2009
10 Golden Rules Of CFD Trading
1. Know your market
Choose a market that you understand. This will help you to take clear views on the direction of price movements.
2. Have realistic trading targets in place
A trading plan should provide a general set of rules which you can refer to. The plan might specify things such as:
• Profit goals (per day, month, year)
• Maximum losses you are prepared to take
• Size of the trade at any one time
• Entry/exit point
Without a set of rules, emotions such as greed, fear and hope may take over and lead you to make irrational decisions. Of course, as you become more confident, these rules can be changed and adapted to any new strategy you may wish to adopt.
3. Don't overtrade
Trade within your financial means. Don't use up your entire margin up with a single opening trade and always have extra margin to cover your position should it go against you.
4. Cut your losses
In a losing situation it is easy to let losses accumulate in the hope that prices will turn around. By getting out of loss making positions early, you will avoid losses getting too large.
5. Use closing orders (stop losses) to manage your risk You can place closing orders (stop losses) on trades both online and over the telephone to help minimise your losses.
6. Expect losses
Even the best traders in the world get it wrong. Analyse your losing trades and learn from your mistakes. Don't get emotionally attached to your trades.
7. Be disciplined
Do not let emotion take over - stick to your rules. Consider the appropriate levels to take profit and losses.
8. Don't put all your eggs in one basket Trade a variety of markets to spread your risk.
9. Don't trade on rumours
Have your own opinion about every trade so that when you are ready to trade you will be confident that you have taken a value and considered view.
10. Keep informed and up-to-date
Make use of all the resources available to you to maximise your understanding of the markets. The City Index Internet Trading Platform is constantly updated to give you the latest news and information from well respected news providers.
34 ISSUE 8 INVEST APR/MAY 09
Choose a market that you understand. This will help you to take clear views on the direction of price movements.
2. Have realistic trading targets in place
A trading plan should provide a general set of rules which you can refer to. The plan might specify things such as:
• Profit goals (per day, month, year)
• Maximum losses you are prepared to take
• Size of the trade at any one time
• Entry/exit point
Without a set of rules, emotions such as greed, fear and hope may take over and lead you to make irrational decisions. Of course, as you become more confident, these rules can be changed and adapted to any new strategy you may wish to adopt.
3. Don't overtrade
Trade within your financial means. Don't use up your entire margin up with a single opening trade and always have extra margin to cover your position should it go against you.
4. Cut your losses
In a losing situation it is easy to let losses accumulate in the hope that prices will turn around. By getting out of loss making positions early, you will avoid losses getting too large.
5. Use closing orders (stop losses) to manage your risk You can place closing orders (stop losses) on trades both online and over the telephone to help minimise your losses.
6. Expect losses
Even the best traders in the world get it wrong. Analyse your losing trades and learn from your mistakes. Don't get emotionally attached to your trades.
7. Be disciplined
Do not let emotion take over - stick to your rules. Consider the appropriate levels to take profit and losses.
8. Don't put all your eggs in one basket Trade a variety of markets to spread your risk.
9. Don't trade on rumours
Have your own opinion about every trade so that when you are ready to trade you will be confident that you have taken a value and considered view.
10. Keep informed and up-to-date
Make use of all the resources available to you to maximise your understanding of the markets. The City Index Internet Trading Platform is constantly updated to give you the latest news and information from well respected news providers.
34 ISSUE 8 INVEST APR/MAY 09
Wednesday, January 18, 2006
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