Question about CFDs

[shortlist]

Hello

I am not intending on buying CFDs right now as I am too new to trading. Although I think I understand the risks of margin lending in a very simple way, can anyone enlighten me further?

Example:

Let's say I have $20,000. Due to the risky nature of CFDs, I choose to play it safe and put $1000 down, giving me on a 90% basis $10,000 of shares to purchase.

Then let's say it all goes horribly wrong and the shares lose basically all of their value. My simple udnerstanding of CFDs says that even though I only fronted $1000 I would have to find $10,000 to pay what I lost and owe. Am I right? I read somewhere you could end up owing more than your original input, but surely you would be prepared for this by making sure you had a contingency to cover 100% of potential losses.

Like I said, no CFDs for me right now, or maybe ever, but I feel I should understand them as much as possible.

 

[Timmy]

Then let's say it all goes horribly wrong and the shares lose basically all of their value. My simple udnerstanding of CFDs says that even though I only fronted $1000 I would have to find $10,000 to pay what I lost and owe. Am I right?

Yes, right (plus any interest that may be due).

 

[shortlist]

Yes, right (plus any interest that may be due).

Thanks Timmy. In this case, how come people talk about how lethally dangerous they are? Surely you just have to make sure you have the funds to cover the full amount lent to you?

My confusion came from reading that you could lose an almost infinite amount, like spread betting on something really volatile. But you're saying you can only lose your original input, plus the margin lent to you, plus the interest?

In edit:

The problem I guess is that people have say $50,000, but instead of buying $5000 of CFDs ($50,000 purchasing power) and having the funds to pay it off should they go wrong, they put their full amount down and buy $500,000 worth of shares? If so, crazy.

 

[beerwm]

you can also short stocks using CFDs,

which could incur losses above your initial outlay.

 

[shortlist]

you can also short stocks using CFDs,

which could incur losses above your initial outlay.

Thanks beerwm. Right - but you must have consciously shorted the stocks though, right? If you're buying and selling to profit in an uptrend in the usual way you can only lose initial sum put down + margin lent + interest incurred?

 

[Trembling Hand]

Thanks beerwm. Right - but you must have consciously shorted the stocks though, right? If you're buying and selling to profit in an uptrend in the usual way you can only lose initial sum put down + margin lent + interest incurred?

No you can lose far more than margin. far more than what is in your account even.

 

[Wysiwyg]

Lucky the loan office is clever enough to look after dummies and give them a polite margin call before the dummy loses the lot. Place a stop loss (where is a personal experience/knowledge/pain threshold thing) and be done with it.

 

[shortlist]

Lucky the loan office is clever enough to look after dummies and give them a polite margin call before the dummy loses the lot. Place a stop loss (where is a personal experience/knowledge/pain threshold thing) and be done with it.

Lucky only dummies trade CFDs without understanding the risks, I guess.

Trembling Hand - your post contradicts some of the information I have been given on here, and I would be grateful if you could explain how you can lose a lot more than margin given that a share price cannot fall an infinite amount. Like I said, I probably will never trade CFDs, preferring straight forward equity trades with my own money, but I need to know how these things work, I think, and I had read a lot of rubbish about them, evidently.

 

[Trembling Hand]

Lucky only dummies trade CFDs without understanding the risks, I guess.

Trembling Hand - your post contradicts some of the information I have been given on here, and I would be grateful if you could explain how you can lose a lot more than margin given that a share price cannot fall an infinite amount. Like I said, I probably will never trade CFDs, preferring straight forward equity trades with my own money, but I need to know how these things work, I think, and I had read a lot of rubbish about them, evidently.

Its easy to lose more than your account in theory. This is how it works.

If you only have to put up 5% margin and you use up all the funds in your account than if the stock moves more than 5% overnight then you will lose the lot. Anything past that and you are in negative. Imagine a situation where it moves 15% or more you are now in the hole for 2 time what you had in the account yesterday :

Or if you use up 1/2 the funds the stock moves 10% overnight you lose all your account.

 

[$20shoes]

I would love to have the personal equity to not require the use of leverage, but I do use CFDs simply to give myself the opportunity to trade more and more positions. BUT my position sizing is based on my actual personal equity. Isn't this how everyone does it??
Otherwise, if you're buying into a position with money you don't own you're taking on some mighty risk but perhaps people who do this don't hold positions overnight and accept that risk. I think TH is referring to a position size in excess of your actual capital base - yes as per THs comments below, the margin swings could knock ya block off, if you're leveraged up

 

[shortlist]

Its easy to lose more than your account in theory. This is how it works.

If you only have to put up 5% margin and you use up all the funds in your account than if the stock moves more than 5% overnight then you will lose the lot. Anything past that and you are in negative. Imagine a situation where it moves 15% or more you are now in the hole for 2 time what you had in the account yesterday :

Or if you use up 1/2 the funds the stock moves 10% overnight you lose all your account.

OK thanks I think I have it. So the real trouble comes along if you put up too large a percentage of your capital to start with, then. In other words you can lose a lot more than is in your trading account, but you would be OK if you had done your maths and only put a small fraction of your capital base into that trading account?

$20shoes

I know what you mean, and I am lucky not to have to rely on margin lending for my investments/trades (when I start making them, anyway....). My interest lies in the research and analysis of governments and companies in order to make an assessment about future movements of equities/forex.

As for CFDs, the way I see it is this: there are two guys, Bob and Bill. They each have $100,000 capital base. Bob goes to a CFD broker and makes use of margin lending to turn 10% of his capital base into $100,000, while Bill makes us of margin lending to turn his $100,000 into $1,000,000.

Bob is making a relatively sensible judgement but Bill's an idiot - that's my take on it.

 

[$20shoes]

As for CFDs, the way I see it is this: there are two guys, Bob and Bill. They each have $100,000 capital base. Bob goes to a CFD broker and makes use of margin lending to turn 10% of his capital base into $100,000, while Bill makes us of margin lending to turn his $100,000 into $1,000,000.

Bob is making a relatively sensible judgement but Bill's an idiot - that's my take on it.

Precisely. But from Bob's perspective, he may still take on more and more positions until such time as he doesn't have a lot of funds left to cover his margin requirements. Then Bob is also asking for at least a margin call, but in a market crash, some real pain.

 

[skc]

As for CFDs, the way I see it is this: there are two guys, Bob and Bill. They each have $100,000 capital base. Bob goes to a CFD broker and makes use of margin lending to turn 10% of his capital base into $100,000, while Bill makes us of margin lending to turn his $100,000 into $1,000,000.

Bob is making a relatively sensible judgement but Bill's an idiot - that's my take on it.

Bob is also an idiot for he decided to pay interest to the CFD provider when he doesn't actually have to.

You will only use CFDs if you want to control positions that are in total larger than your capital base. Otherwise you might as well just buy direct equities.

And Bill may not be such an idiot. He has stop losses in place that will limit his loss on $1m position to only $50K, which is less than his total capital.

The key is how much is at risk.

 

[$20shoes]

Bob is also an idiot for he decided to pay interest to the CFD provider when he doesn't actually have to.

You will only use CFDs if you want to control positions that are in total larger than your capital base. Otherwise you might as well just buy direct equities.

And Bill may not be such an idiot. He has stop losses in place that will limit his loss on $1m position to only $50K, which is less than his total capital.

The key is how much is at risk.

True, but for the sake of the exercise, I'm assuming Bob is basing his position sizing from his actual personal capital amount, so that, although he may end up controlling positions larger than his capital base, he can account for a string of losses from his actual capital base.

Hasn't Bill just wiped out 50K of his original 100K? ouch. Im sticking with Bob who's a sucker for paying interest ( at least it could be a death by a thousand cuts, and not one fell swoop...lol)

 

[shortlist]

True, but for the sake of the exercise, I'm assuming Bob is basing his position sizing from his actual personal capital amount, so that, although he may end up controlling positions larger than his capital base, he can account for a string of losses from his actual capital base.

Hasn't Bill just wiped out 50K of his original 100K? ouch. Im sticking with Bob who's a sucker for paying interest ( at least it could be a death by a thousand cuts, and not one fell swoop...lol)

While I was interested to read about Bill's $1,000,000 CFD with a 50k stop loss - too good to be true, etc - I'm not in either Bob's or Bill's camp because I want to invest/trade my own money only. I have never borrowed money for anything (mortgage excluded) and I don't want to start now! So I'm with "Ben" my third character - who has his own money and invests/trades about 15% of the capital.

 

[Wysiwyg]

You will only use CFDs if you want to control positions that are in total larger than your capital base. Otherwise you might as well just buy direct equities.

Call/Put Options are another alternative. Although I don`t have much knowledge on them except for a Bernie Schaeffer Options 101 CD.

 

[johenmo]

Shortlist, "Supercharge your trading with CFDs" by Jeff Cartridge is a good novice read (bought it recently). He mentions the initial margin is not what kills people, it's the rest of it (forgot the term right now). And good chapter on risk - but like a lot of others.

And the type of stop loss can save you or not - if the price gaps in the wrong direction.

Your library may have the book. Otherwise it's $25.

 

[shortlist]

Shortlist, "Supercharge your trading with CFDs" by Jeff Cartridge is a good novice read (bought it recently). He mentions the initial margin is not what kills people, it's the rest of it (forgot the term right now). And good chapter on risk - but like a lot of others.

And the type of stop loss can save you or not - if the price gaps in the wrong direction.

Your library may have the book. Otherwise it's $25.

I'll try and track down a copy, thanks johenmo! I have a funny feeling I would be better off if I knew what the hell I was talking about...

 

[jono1887]

No you can lose far more than margin. far more than what is in your account even.

shouldnt your broker close your open positions before this happens... they generally dont want to loose money either :

 

[danno75]

Just a couple of statements to clear my head as I am still in the decision process about CFD's.

1.
As a starter if I had $10,000 to begin with and was to buy standard shares with the thought of trading in the medium term >1 week <6 months and I chose to buy 5 lots of $2000 (not including brokerage for this example) I could get my $10,000 worth.
If I had $10,000 in a CFD account with leverage to $50,000 but only chose to work with the $10,000 as maximum exposure and end up with the same 5 x $2000 packages would that keep things a bit safer.
The reason I ask is that I am not very often home in the mother country and do not want to have to deal with excessive amounts of mail as per standard stock purchases that send out share certificates, board meeting announcements etc.
2.
Currently the online broker I use charges around $38 for an equity trade but only $11 or 11% depending on the size of the trade plus interest so that could be one reason for going with the CFD trades i.e. reduced brokerage?

Any words of wisdom would be appreciated

Danno