Jeffrey Hutton: Contracts For Difference or CFDs have been in the Australian market for about 10 years now, but are they more risk than reward? Joining us to tell us what we've learned since their introduction is Ashley Jessen from Capital CFDs. Ashley, thanks for joining us.
Ashley Jessen: Thanks for having me, Jeff.
Hutton: Ashley, do CFDs stack up as an investment?
Jessen: Yeah, absolutely. It's a good question. I mean CFDs haven't necessarily got the best wrap as far as risk is concerned, I guess. During volatile markets, any trader needs to obviously protect the downside and protect their risk, that's the number one rule of any successful trader. You've always got to protect the downside.
Now with Contracts For Difference, they are a leveraged instrument, so they give you access to greater gains, but they also give you access to greater losses as well. So, when you're trading a product like a Contract For Difference, one of the things to keep in mind is that when the volatility increases, you have opportunity, obviously much more opportunity than you normally would, but when you think about it, you always control the amount of leverage on your account. It's one of the things with CFDs, is the amount of leverage that you get access to.
So, during the times when the market is quite volatile, you can always scale back your leverage, and that's one of the smarter things to do, and always keep your stop-losses nice and tight, and just make sure that you're in control of the amount of risk that you have on your trades.
Hutton: Maybe this is a good time to stop and explain how they work.
Jessen: Yeah. Well, let's start off with CFDs or Contracts For Difference. CFDs enable you to mirror - or they mirror the underlying performance of the stock holding index that you're trading. So, say for example, you wanted to trade BHP. Well, CFDs enable you to trade BHP, but let's say you wanted to buy $10,000 worth, instead of putting 100% of the funds upfront, like you do with say shares, you only need a small amount of money upfront in order to control the full amount.
So, you benefit from all the full movements of the contract for difference, or of the underlying share, but you only need, say 5% of the money upfront. Same with access to indices around the world and foreign exchange, CFDs basically give you a broad market. You can trade anywhere around the world, basically with one piece of software, and you're pretty much ready to go.
Hutton: So you don't have to come up with all the cash upfront?
Jessen: Yeah. So, say for example, BHP is running at just say $40, you wanted to buy 1,000 of those. Well normally, you would have to front up $40,000 cash. When it comes to CFDs, you may only need to put in approximately 5% of the money upfront. So, instead of putting up $40,000, with $2,000 of your own money, you can control $40,000 worth of BHP shares.
So, one of the things that investors need to be really mindful of, and traders in particular, is how much leverage you have, because obviously the more leverage you have, the greater the chance of wins - bigger wins, but the greater the chance of also the downside as well.
So with leverage, comes a bit of a double-edged sword, you need to obviously be mindful of the downside and protect that downside risk, which we were talking about just a second ago with regards to stops. So, you always want to make sure you're running stops with your trading to limit the downside. It's really the only way that you can really look after your portfolio to make sure that downside is covered.
One of the things that we were talking about a little bit earlier was that when you have a loss - and in particular, we have any sort of trading product - if you have a loss, say a 25% loss on your portfolio, it takes 33% just to get back to breakeven. A 50% drop in your portfolio. It will take a 100% just to get back to breakeven.
So, the larger your losses, the higher - that the harder it actually is to get back to just even breakeven, let alone profit. So, smart traders whether they are trading CFDs, futures, foreign exchange, or any of those products, the smart traders will always limit their downside and make sure they keep them nice and small.
Hutton: Just how much in terms of loses should an investor tolerate?
Jessen: Well, very good question, and this is one of the toughest questions, because getting in and buying a position is actually quite easy, but knowing when to get out, whether in profit, or in a loss, is one of the questions that stumps a lot of traders. Usually couple of ways you can determine that: one of them is technical. So, you look for the technical indicators on the chart and you might look for common support areas and a support level is basically where the stock may have come down. It may have hit a certain point, rallied back up, and it might be approaching that level again.
So at some level, the investor is out there and the traders say BHP, or the index or the Aussie dollar represents good value at this price. So, say even the Aussie dollar as an example, when it gets to parity, some people might say that's excellent value and it may have bounced off that level a few times.
So smart traders normally put their stop just below those support levels, just to give themselves a little bit of room just in case it hits it again and then bounces off and rallies again. So say as an example one of the most widely used risk management principles is never risking more than 1% to 2% of your capital in any one trade at any one time.
So, if you're going to take position in BHP, say you've got $20,000 of your money in cash, 1% of that is just $200. So, you take a trade on BHP and then if BHP were to move against you more than $200 or $200, then you would take a loss on that trade and you would move on to the next trade.
So, the number one rule of successful trading is always to your losses small. So, you keep those stops in your - that the overall portfolio, you're never losing too much of that. As I was saying 50% loss takes a 100% to breakeven. If you're sustaining losses of more than 1%, 2% or 5% of your portfolio it just gets so much harder to get back to breakeven.
Hutton: This might be a bit cheeky, but would you sell a CFD to your mother?
Jessen: That's a very good question. CFDs are for a more of an experienced trader. So if my mother was into trading, which she isn't then there would be - it's not a product that is difficult to understand.
Basically it mirrors the underlying and you need to control the amount of leverage that you have on that position, all the positions that you take. So, as long as you understand the leverage aspect to it, and the fact that you the trader - you always control the leverage on those positions.
So it's not the broker that controls the leverage, it's you the trader. So if you use that in a sensible fashion then CFD is an effective tool. So long as you understand the leverage, the more leverage, the bigger the wins, the bigger the losses and the lower the leverage the more you can control it.
Hutton: Ashley Jessen, good luck to you and your mum. Thanks for joining us.
Jessen: Thanks a lot Jeff.
Hutton: It's my pleasure.