Trading CFDs

[robots]

Re: Trading CFD's

hello,

do CFD's have an end date?

are they like futures and options based on a month or time frame?

if so, why is it?

thankyou
robots

 

[scsl]

Re: Trading CFD's

hello,

do CFD's have an end date?

are they like futures and options based on a month or time frame?

if so, why is it?

thankyou
robots

CFDs have no end date, so you can hold a long or short position for as long as you like. This is because it is like holding a traditional share, except for the fact that you only have to put up a fraction of the total position. Also, there is interest payable/receivable, depending on whether you go long/short.

 

[robots]

Re: Trading CFD's

hello,

would trading CFD's would be comparable to getting a margin loan?

just looking at options to get margin loan or use CFD's for trading

thankyou
robots

 

[Magdoran]

Re: Trading CFD's

For short term market speculation, simply you can not beat CFDs. However,one has to be aware of the leverage factor. If your stock goes down a lot, then you will lose a lot. Best way is to use caution using cfds close to agms or close to profit announcements dates. You can gauge when these dates are on by watching previous dates in the asx announcements lists. Of course, one can not foresee a profit downgrade or a takeover announcement. Although, chart activity should alert you to an extent. ...

From my own experience, i lost some good money on warrants in the past (part of my education I guess) but not with cfds. I never hold more than one
position overnight and this only if it is a winning one. Also, i never alert the cfd provider of my stop loss.

And I still use warrants but I try to use long dated installment warrants. This deserves a whole discussion. I have not the time for this now.

In my view a trader should be fully versed in a range of instruments, and should select the best instrument for the situation, and not be biased to one instrument.

Time frame is important. For intraday trading, there are disadvantages using options in that the market makers often wait 20 to 30 minutes at opening to make a market. This can be critical for day traders. However if position trading, options can be highly effective, but require the requisite knowledge to position correctly.

Here is a repost of my earlier comment on post 12 in “The idiots way to options riches” thread:

I would argue that at their best, options should outperform CFDs hands down when it comes to risk to reward, but to do this, that the options environment needs to satisfy specific conditions, and where these conditions are not met, that other instruments including CFDs may be more appropriate, but not the other way around. What I’m saying is, given a general choice, options should be considered above CFDs.

One key variable though is the capacity and actual knowledge of the individual trader/investor. If you can’t develop a sufficient understanding of options to a level to trade them, then this effectively rules this instrument out of contention. However, in my view, if you can’t figure options out, I would have serious doubt about such a person using any kind of derivative product period. I’d tend to think they’d be better off getting someone else to manage their investments such as considering using a managed fund.

This may sound harsh, but if you don’t have the intellectual capacity to understand derivatives to this level, trying to use related leveraged instruments just doesn’t add up to me – either you’ve got the ability to learn or you don’t. So, I tend to agree with Wayne regarding which instrument to use, it all depends on the situation.

The problem I have is that many CFD traders are not aware of their full exposure to risk, and often are not capable of evaluating the best instrument available to them based on their market view of a potential trade.

I’ve sat down with CFD traders and compared notes looking at the real risk to reward involved with a range of trades comparing CFDs and options and how they performed.

While sometimes good options trades are not available for a stock/index/commodity future/Forex (in which case perhaps using a CFD may be the better alternative in some cases), generally I have found that if you have sufficient options knowledge, options can significantly outperform CFDs in terms of risk to reward, if the appropriate strategy is available (sometimes appropriate options aren’t available maybe due to volatility problems, or liquidity/open interest, etc).

I went through one example with a trader (which was representative of the general findings overall) where the option slightly outperformed the CFD in terms of reward, but was about 5% the exposure - yes, that’s 20 times less exposed - than the CFD position. But each underlying and options market may differ significantly depending on a host of variables, so this comparison can vary widely.

So, I would argue that it is essential to fully understand all the instruments you are considering, and that the trader/investor develops the ability to assess the risk to reward proposition they are considering entering. That’s what using derivatives should be all about, minimising risk in context with maximising reward.

Sometimes a CFD will be the better alternative, but it is having the ability to assess which instrument is best based on the trader/investor’s style that ultimately separates the amateurs from the professionals.

Another issue is that many people using CFDs don’t understand their real exposure. If you’re using a 5% margin for collateral, that means that you are borrowing 95% of the full amount the position is worth.

So, for example, let’s say you enter long $50,000 worth of XYZ stock in CFDs while it is trading around $10, so your margin requirement is $2,500. Let’s say that overnight a major negative news event happens, and the next morning the stock opens at $5.00.

You’ve just lost around $25,000 if your position is closed (which will happen if your account is not big enough to put up the margin required), but thought you were risking $2,500 if you didn’t understand the real nature of the exposure which was $50,000.

Just think about how many people may load up several positions like this thinking all they need to do is leverage $2,500 at a time. What if the market moved significantly against them? It is very easy to be exposed to over $100,000 of risk if you don’t know what you’re doing.

Even though strong moves like this are uncommon, they do happen, and they are a real risk. I know a trader who lost over $100,000 in this way in under a month because he didn’t manage his positions, and didn’t realise his real exposure. All you need is one major loss to wipe out months of good trading… think about it.

Ok, so there are guaranteed stop losses (GSL) available for CFDs which can be used to limit risk, but this is usually set at a maximum 5% loss in the underlying, and often has a fee to establish one, and for some providers a fee to move the stop loss as the underlying moves. This is certainly preferable to being totally exposed, but can still leave the trader/investor exposed to considerable risk. 5% for each large position can add up very quickly.

Another issue about CFDs is the exposure to having your account cleaned out. This happens if a position moves against you, and there are not sufficient funds available to cover the growing margin requirement. I’ve heard of CFD traders having their account cleaned out on an intra day spike, only to see the stock rally up past where it opened and continue on in their direction. But if the account can’t meet the margin requirements at any time, the position is automatically exited at a maximum loss to the account. This is a real problem if it is not managed, and in my view a major disadvantage compared to options.

With options, there are a myriad of ways to control risk that are not available with CFDs. Firstly, even using a simple long call or put, the risk is limited to the initial premium (plus OCH fees and brokerage). You can’t lose more than you paid. Then there are a range of spreads available to cap risk, each with application depending on the market conditions.

Secondly, there are no interest payments required on a long position (or a short one for that matter – although you can receive interest from CFDs for short positions) like there is with CFDs. Certainly, there is time decay, but this can be managed, and ameliorated, or even utilised using various options approaches (sold options suffering time decay are helpful to the seller).

Thirdly, if you buy a put for a bearish position, you don’t owe the dividend at ex div like you would if you were short the underlying with CFDs (Of course if you were short a call that is assigned before ex div, you would owe the dividend).

In addition, options are regulated instruments with significant underwriting, where CFDs are essentially an OTC (over the counter) instrument, and there is a risk that the CFD provider could become insolvent, and part or all of the trader/investors’ funds may be lost in this event.

So, some key issues are based on your view of the market, how long you intend to be in the position, and what the best risk to reward strategy is available balanced against the probability of success.

Add another dimension of a range of other instruments available such as futures, warrants, forwards, swaps, bonds and debt notes, and other instruments such as convertible notes, and you have a smorgasbord of choice. The challenge though is developing the capacity to evaluate all these instruments, and then effectively evaluating the best risk to reward approach with the best probability for success.

While I understand when I hear the response that CFDS are ostensibly simpler than options, I would argue that in the broadest perspective that this is a misconception. CFDs are actually more complex than they seem. Sure they are perhaps less complex than options, but they’re quite dangerous in the wrong hands, and certainly less flexible, and arguably can be much more exposed to risk. Sure, it’s harder to work out an options strategy at first, but if you don’t do the due diligence, you’re really leaving yourself open to potential ruin.

In my view using liquid options in tradable markets should outperform CFDs significantly because the risk is capped, and can be as good as 20 times less the exposure. This can make a huge difference to the bottom line, but requires a full understanding of the instrument.

I hope that expands the field of discussion, and helps to clarify some important technical points.


Regards


Magdoran

 

[MichaelD]

Re: Trading CFD's

So, for example, let’s say you enter long $50,000 worth of XYZ stock in CFDs while it is trading around $10, so your margin requirement is $2,500. Let’s say that overnight a major negative news event happens, and the next morning the stock opens at $5.00.

You’ve just lost around $25,000 if your position is closed (which will happen if your account is not big enough to put up the margin required), but thought you were risking $2,500 if you didn’t understand the real nature of the exposure which was $50,000.

In my opinion, the level of risk of this transaction is in the eye of the beholder and therein lies the danger of CFDs. The (very) unwise would see this as them risking $2,500, where the $2,500 is a substantial portion of their trading capital.

Personally, if I were to take such a large position I'd view my risk as the entire exposure of the position - I'd have 1R deposited with the CFD provider which would more than cover the initial margin requirement and I'd have a whacking wad of cash sitting in a cash management account (of the order of 7 times the $50,000 or so - my max individual position size is 15% of total capital) to keep the risk of the position under control as a percentage of overall trading capital.

The temptation for the weak is to look at the unused cash and want to spend it all on bigger position sizes.

 

[Magdoran]

Re: Trading CFD's

In my opinion, the level of risk of this transaction is in the eye of the beholder and therein lies the danger of CFDs. The (very) unwise would see this as them risking $2,500, where the $2,500 is a substantial portion of their trading capital.

Personally, if I were to take such a large position I'd view my risk as the entire exposure of the position - I'd have 1R deposited with the CFD provider which would more than cover the initial margin requirement and I'd have a whacking wad of cash sitting in a cash management account (of the order of 7 times the $50,000 or so - my max individual position size is 15% of total capital) to keep the risk of the position under control as a percentage of overall trading capital.

The temptation for the weak is to look at the unused cash and want to spend it all on bigger position sizes.

Fully agree with you Michael,


An excellent post. Good points from a practical perspective.


Regards


Magdoran

 

[Kauri]

Re: Trading CFD's

In my opinion, the level of risk of this transaction is in the eye of the beholder and therein lies the danger of CFDs. The (very) unwise would see this as them risking $2,500, where the $2,500 is a substantial portion of their trading capital.

Personally, if I were to take such a large position I'd view my risk as the entire exposure of the position - I'd have 1R deposited with the CFD provider which would more than cover the initial margin requirement and I'd have a whacking wad of cash sitting in a cash management account (of the order of 7 times the $50,000 or so - my max individual position size is 15% of total capital) to keep the risk of the position under control as a percentage of overall trading capital.

The temptation for the weak is to look at the unused cash and want to spend it all on bigger position sizes.

And the alternative is to use a GSL. I personally only ever trade CFD's that have a GSL facility available. With my provider practically all the GSL'able CFD's with a 5% margin have a GSL premium of .3%. That way I have my risk for the $50000 example you are using capped at 5% ($2500) for a once off premium cost of $150. In my opinion any leverage employed with open ended risk is courting disaster, be it shares, options, CFD's, futures, FX, property, et al. My opinion is that all CFD's should have GSL "insurance" as a compulsory feature, much as insurance is compulsory on any asset that a bank/financial institution lends money on. Mind you it may cut down on the providers profit..

 

[RichKid]

Re: Trading CFD's

And the alternative is to use a GSL. I personally only ever trade CFD's that have a GSL facility available. With my provider practically all the GSL'able CFD's with a 5% margin have a GSL premium of .3%. That way I have my risk for the $50000 example you are using capped at 5% ($2500) for a once off premium cost of $150. In my opinion any leverage employed with open ended risk is courting disaster, be it shares, options, CFD's, futures, FX, property, et al. My opinion is that all CFD's should have GSL "insurance" as a compulsory feature, much as insurance is compulsory on any asset that a bank/financial institution lends money on. Mind you it may cut down on the providers profit..

Hi Kauri,

My 2c worth:


Completely agree about the risks of uncapped loss, regardless of the instrument or market.

The problem with GSL's is the added costs, can be significant as it's a and they can add as you extend the gsl expiry or change it's distance.

Imo, it would be in the interests of CFD providers to have gsl's across the board as that'll keep clients trading for longer and more often rather than having them wiped out quickly. There would be problems with offering gsl's on all stocks as some would not be hedgeable (ie can't find stock to borrow or no derivatives available).

This is an excellent topic to be discussing guys, let's see if we can flesh out the issues completely.

 

[Kauri]

Re: Trading CFD's

Hi Gp..
I trade with IG and there is only the initial once off payment for the GSL based on the total value at purchase, and thereafter you can adjust the GSL as often as you require (so long as it is never less than 5% from the price at the changing time), for no extra cost. They also have a GSL available on Fx, futures etc but rather than a premium charge they build it into the spread.

 

[MichaelD]

Re: Trading CFD's

And the alternative is to use a GSL.

I tend to disagree.

In my opinion, a GSLO is merely a smoke and mirrors trick by CFD providers to get you to put your stop in the market.

I know by backtesting that a system with an intraday stop is less profitable and has more drawdown than a system with an EOD stop which is not placed in the market.

What does a GSLO achieve?
1. A steady extra income stream for the CFD provider (= a steady extra drain on your capital)
2. It alerts the CFD providers to where you place your stop.
3. It puts your stop in the market where it can be hunted down.
4. It will result in the CFD provider giving you more margin to play with.
5. In return, you get protection from black swan events.

I fail to be convinced so far that a GSLO will in fact improve system expectancy - that its benefit outweighs its disadvantages.

If anyone has any robust testing to prove this point one way or the other, I'm certainly interested in hearing about it. As with many things on the market, all is not always as it seems.

 

[Kauri]

Re: Trading CFD's

I know by backtesting that a system with an intraday stop is less profitable and has more drawdown than a system with an EOD stop which is not placed in the market.

How does a stop placed 5% from the current price qualify as an intraday stop as opposed to an EOD stop?
How do you backtest a system which has an EOD stop that is not placed in the market??

1. A steady extra income stream for the CFD provider (= a steady extra drain on your capital)

Yes , I feel the same way about my house, contents, car, insurance.

2. It alerts the CFD providers to where you place your stop.)

Yes.

3. It puts your stop in the market where it can be hunted down.

Yes, as I use DMA (true DMA, I watch the order processed on an independant market depth screen) CFD's which are obviously some of the largest capped co's on the ASX, if anyone wants to hunt down my humble positions stop by physically moving the underlying by 5% then I question their sanity and business acumen.

4. It will result in the CFD provider giving you more margin to play with.

My bank is constantly offering me a higher limit on my credit card, also access to the equity in my home, I don't accept their offers either.

5. In return, you get protection from black swan events.

Thats why I use it, in fact that is why all my major assetts are insured.

I fail to be convinced so far that a GSLO will in fact improve system expectancy - that its benefit outweighs its disadvantages.

I don't recollect expectancy being mentioned, however, I don't magine it does improve it, what I utilise it for is insurance against that 1 in a 1000 event that will never happen to me.
That being said, I have not yet exited a position on a GSL, I actually monitor my trades and set and execute manual exits at more relative points than an arbitrary 5% area. The GSL is purely insurance.

 

[MichaelD]

Re: Trading CFD's

How does a stop placed 5% from the current price qualify as an intraday stop as opposed to an EOD stop?
How do you backtest a system which has an EOD stop that is not placed in the market??
I don't recollect expectancy being mentioned, however, I don't magine it does improve it, what I utilise it for is insurance against that 1 in a 1000 event that will never happen to me.

A GSLO will trigger if the price action touches the GSLO price at any time during the course of trading. An EOD stop is only triggered when you look at the chart at the end of the day and notice that the price has dropped to or below the stop loss point on the trade (i.e. only on the CLOSE price). You then make arrangements to sell the next day.

Backtesting is simple - you just code an exit as follows;
For an intraday stop - if today's LOW <= STOP, exit TODAY at STOP price.
For an EOD stop - if today's CLOSE <= STOP, exit TOMORROW at OPEN price.

Your insurance analogy is an apt one - you're insuring yourself against the possibility of a position wipe-out or slippage which you cannot tolerate. My contention is that it may well be more profitable in the long run not to pay for the insurance, but to accept the fact of the occasional black swan event in trading.

Do you (or I) know the odds of a black swan event? Nope. I'll bet, though, that the CFD providers do. Since they are nothing more than professional bookmakers on financial markets, I'll also bet you that they are the ones that net benefit from GSLOs, not us - just as insurance companies profit from selling insurance. Why else would they offer them?

 

[wayneL]

Re: Trading CFD's

Do you (or I) know the odds of a black swan event? Nope. I'll bet, though, that the CFD providers do. Since they are nothing more than professional bookmakers on financial markets, I'll also bet you that they are the ones that net benefit from GSLOs, not us - just as insurance companies profit from selling insurance. Why else would they offer them?

Good point MD,

Just like "insurance" at the blackjack table... a net winner for the casino.

 

[Kauri]

Re: Trading CFD's

I neglected to declare that I have a little bit of bias when it comes to GSL's..
Pre GSL, EOD stop, earnings forecast update..... what seemed to be a black swan turned into my own bloody Jumbo!! Cost me over 30% of my bank... I know...it will probably never happen again...

 

[MichaelD]

Re: Trading CFD's

Cost me over 30% of my bank... I know...it will probably never happen again...

Not wanting to be negative, but if this sort of event could expose you to that degree of loss then your position sizing is WAY too high to be safe. No wonder you feel the need for insurance.

Personally, I will never place myself in a position where even a complete wipe-out of a position (i.e. liquidation with no return to shareholders) will lose me any more than 15% of my overall capital.

 

[TraderPro]

Re: Trading CFD's

Not wanting to be negative, but if this sort of event could expose you to that degree of loss then your position sizing is WAY too high to be safe. No wonder you feel the need for insurance.

Personally, I will never place myself in a position where even a complete wipe-out of a position (i.e. liquidation with no return to shareholders) will lose me any more than 15% of my overall capital.

Have you guys ever thought, if the market were to crash like it did in the eighties, and since you are trading a leveraged instrument... any large movement against your portfolio would leave you financially stuffed?

Is this kind of risk something that all traders just accept?

I mean no ordinary stop loss will defend against this since the market would gap down, perhaps a gslo could protect you in the case of any crash happening?

 

[Kauri]

Re: Trading CFD's

Not wanting to be negative, but if this sort of event could expose you to that degree of loss then your position sizing is WAY too high to be safe. No wonder you feel the need for insurance.

Personally, I will never place myself in a position where even a complete wipe-out of a position (i.e. liquidation with no return to shareholders) will lose me any more than 15% of my overall capital.

That is why I stopped trading, studied what I was doing, and started using GSL's.
Say I had $100000 for a bank and wanted to go unprotected via CFD's in BHP, then by risking no more than 15% (or $15000) on a complete wipeout scenario then the amount I purchase would be 15000/26.5=566 shares.
a) Via CFD= 5% margin + (5% margin*10% for divi allowance)=$825 with $14175 put away in case of disaster = $15000. Total risk = $15000....
b) Via normal purchase of shares = $15000. Total risk = $15000....
c) Via CFD DMA GSL = 5% margin + (5% margin*10% for divi allowance) + 0.3% GSL premium = 750 + 75 + 45 =$870. Total risk = $870.
Should also mention that under my trading guidelines (another contentious issue on another thread ) that no one position (total share value) will represent more than 15% of my bank and my total use of funds available (margin etc) will not represent more than 30% of my available funds.
Now why would I use a or b over c, in fact why would I bother with leveraged a as opposed to b, apart from a small interest gain? In a and b I could have approx 7 open BHP type positions with all my $100000 committed and ultimately all at risk whereas with c I can comfortably have 15 BHP type positions open with less than 15% of my funds committed and at risk. If I am going to use leverage I want to know my total liability under a worst case scenario and I want to be in control of my risk, not at the mercy of external factors ( and unexpected earnings downgrades ).

 

[MichaelD]

Re: Trading CFD's

whereas with c I can comfortably have 15 BHP type positions open with less than 15% of my funds committed and at risk.

Now THIS is an interesting post - 'tis the first time I've ever read what appears to be a compelling argument FOR the use of GSLOs as a risk mitigation tool.

Time to do some number crunching of my own methinks.

 

[MichaelD]

Re: Trading CFD's

Have you guys ever thought, if the market were to crash like it did in the eighties, and since you are trading a leveraged instrument... any large movement against your portfolio would leave you financially stuffed?

Crashes don't happen out of the blue - there are plenty of technical warning signs before the big fall. Studying how my plan would have traded through the 1987 crash shows that the system would have progressively shut down in the days before the crash - stops got hit, but there were less and less buy signals so the portfolio progressively moved to cash.

 

[Kauri]

Re: Trading CFD's

Have you guys ever thought, if the market were to crash like it did in the eighties, and since you are trading a leveraged instrument... any large movement against your portfolio would leave you financially stuffed?

Is this kind of risk something that all traders just accept?

I mean no ordinary stop loss will defend against this since the market would gap down, perhaps a gslo could protect you in the case of any crash happening?

Apart from market crashes, what would happen if (God forbid) you had a stroke, car accident..... and were comatose, would anyone manage your account for you?? (Sorry about the gloom, bad night.. )