Posts Tagged ‘CFD’

How much money could I lose trading CFDs?

Friday, July 17th, 2009

Before placing any contracts for difference (CFD) trades you should ask yourself the question of “How much money could I lose?”. If you are to trade responsibly you should always be focusing on what you could lose, not what you could win. If you are focusing on how much you could win then you are either at high risk of losing a lot of money, or you could even be a gambler rather than a trader.

There are several different ways of looking at how much money you could lose.

Lose as much as you put in

A small number of CFD providers will cap your losses at the amount of money you have in your account (or offer a lower risk account which guarantees this). If you have an account with a company who does this then your worst case loss is obviously whatever money you put into your account.

Even if your CFD provider doesn’t cap your losses then you may be able to fix your maximum risk by using a guaranteed stop. Unfortunately there is usually an extra charge for these, often in the form of a larger spread.

Lose your entire position size – going long

Most CFD account providers have agreements that say you must cover all your loses – which can be larger than your account balance. They will usually close out your trade before your account balance hits ‘0’ but in a very fast moving market you might be closed out with a negative balance.

If you are betting long then your theoretical maximum loss will be your total position size. If you bought £10,000 of Vodaphone shares using CFDs then you may have only needed to put down a £100 deposit (if we assume a 1% deposit requirement) but your loses could far exceed that £100. Your maximum loss would occur in a situation where the share price went down to 0. If you’d used CFDs to buy £10,000 of shares and the price suddenly plummeted to 0 then you could owe £10,000 if your trade wasn’t automatically closed out.

Could this happen in real life? Certainly share prices can go down to 0 – recent cases of large companies collapsing include Enron and Lehman Brothers.

If you were going long on indicies, such as the FTSE 100 then your theoretical loss would be the loss that would be incurred if the index went down to 0. As I write this the FTSE100 is at 4365. If I bought at £1 a point then my theoretical risk is £4365.

Unlike shares which can go down to 0 a share index is very unlikely to. It the FTSE 100 ever dropped to 0 then that would probably mean that the UK had been nuked to oblivion. In which case you may well be dead and your CFD broker wouldn’t exist either! Very unlikely but it is always worth bearing in mind just how much money you are playing with.

Could the value collapse so fast that you would end up owing far more than your account balance? You can end up owing your CFD provider more than you balance if you have a very large and highly leveraged position, and things move fast. In this case it may simply not be possible to liquidate your position fast enough to prevent your loses.

Losing a fortune – going short

The amount you can lose is often defined in terms of prices going down. Of course with CFDs we can bet on prices going up and down. How much could you lose by going short?

In theory you could lose an infinite amount of money!

I’m not saying it is likely – just theoretically possible. Lets imagine that you think UselessPowerPLC is going down. It is at 5p per share and you think it will fall further. You sell £10,000 worth – this is 200,000 shares. It is a small share and you need a 10% deposit. In other words you have to put down a £1000 deposit. They make an unexpected announcement – they have perfected fusion power, using patented technology, and can now produce almost unlimited amounts of power extremely cheaply. The company will make billions! The share price rockets to £20 and moves so fast that your CFD provider can’t close your position out in time. Suddenly you owe your CFD provider £3,990,000 (200,000 * (£20 – £0.05)). Yes – nearly £4 million. Crikey. Stretching the bounds of believability perhaps, but it makes a point about how risky the CFD game could be. Especially if you make stupid bets!

Is any of this really likely to affect me?

How fast could prices move? Very fast. Look at the stock market crash page on Wikipedia. How would your account have coped during one of those days?

My doom-munging scenarios wouldn’t normally happen of course. You CFD provider knows that trying to claw back debts from customers is much harder, and more expensive than simply deducting the money from their account. This is why they have automated systems in place to try to automatically close your positions before you get into this predicament. If you do find yourself in this predicament then you should look at the way you are trading – it probably means you did something very stupid, i.e. holding positions that were far too large and highly leveraged.

Although the unlikely is by definition ‘unlikely’, is always worth thinking beyond your usual risk scenarios. Don’t forget that a factor of the current credit crunch was that banks rejected the sudden default of hundreds of thousands of mortgages as being such an unlikely thing to happen that it wasn’t worth taking seriously. Ooops! Fortunately the banks had the government to bail them out. If you mess up then the banks certainly won’t be bailing you out.

The simple moral – consider the usual risks, and then consider beyond the usual risks. If you are still happy then you can play the CFD game. If you aren’t happy then maybe you should put you money in the bank.

Top Trader 2009 Competition

Monday, June 29th, 2009

RBS marketindex is launching a competition to find the best CFD trader. You trade using a demo account and each week there will be prizes for whoever increases their account by the most. Registration is open from the 29th June and the competition starts on July 6th.

Prizes are £5000 cash, a Dell laptop and an iPhone 3GS 16GB.

As this is a competition the strategy you adopt for trading should be different to how you would normally trade. In the real world slow and steady is the best way to make way money from trading. This strategy won’t however win you any prizes in a competition like this!

If you want to win you will need to place high risk/high reward bets. Yes there is a good chance that you will blow your account, but as it is only a demo account it doesn’t matter. You have to make at least 20 trades in the four weeks of the competition to qualify for the prizes.

If you want to experiment with a new trading platform without risking your real money then this could be a good opportunity to do it. And unlike a standard demo account there is a very small chance that you might win something at the end.

If you enter then good luck, and let me know how you got on.

You can find the full details here.

Footnote: RBS marketindex is run by ABN Amro. This is the Dutch bank that RBS (in a consortium with a few other institutions) took over in 2007 in a deal worth 70 billion Euros. At the time RBS was lead by Fred Goodwin, and the deal is widely regarded as one of the main factors that brought RBS down.

My first trading mistakes

Monday, June 15th, 2009

I first opened a CFD trading account about three months ago. In that time I’ve already made quite a few mistakes but hopefully I’ve learnt from them. Here are some of them.

Not checking the spread before entering a trade

If for example the index is moving in a range of say 10-20 points and you want to do a short term bet then opening a trade with a spread of 10 is going to make it almost impossible for you to come out with a profit.

Similarly if the index is trending then a large spread will still make it much harder for you to make a profit – any profit will be smaller because of the spread and any loss will be magnified.

Lesson: Make sure the spread is appropriate for the type of trade you are going into before you enter.

Forgetting about pending orders

Having pending orders which you have forgotten about can be very expensive as trades can then be opened without you even being aware of it. You could get lucky and it could go your way but more likely you’ll lose.

Lesson: If your platform supports it have the pending order blotter on screen at all times. Check for any pending orders before you leave your screen and before you close the trading platform down.

Not fully understanding your trading platform

I’ve had one situation that worried me. I somehow got into a trade that I wasn’t expecting (see forgetting about pending orders above), and I couldn’t work out how to close it down. It was a Forex trade and as the trading ticket wasn’t on screen I couldn’t work out whether I needed to buy or sell! It took me a few minutes to figure it out. No major loss was made and it could have been a lot worse.

Lesson: Read the manual before you start!

Not setting the default trading sizes correctly

For a particular stock the default trade size was 10,000. I wanted to trade much smaller so I set the market buy/sell size to 100. However I forgot to change the default trade size for the stop order as well. I entered the trade by selling 100 shares. I set a stop – which I didn’t properly check! The stop was hit and it bought 10,000 shares! Ooops!

Closed it quickly and of course it turned a small profit into a much larger loss.

Lesson: Make sure that you exit a trade and set your stops correctly! Especially if you will be away from your trading screen for any length of time. And check your stops when you have created them to make sure they are correct.

Review: Diary of a CFD Trader by Catherine Davey

Tuesday, June 9th, 2009

Catherine Davey is a regular writer of trading articles. Perhaps to prove that she could put her money where her mouth is she decided to spend three months (14 weeks) trading CFDs and write a diary of her progress to show that it is possible to make money this way.

As she soon discovers it isn’t as easy as she initially though. Her account decreases at quite a rapid rate and she wonders if she has made a big mistake.

The book contains details of the trades that she makes – most of these are CFD share trades on companies listed on the Australian stock exchange. She does a small amount of commodity trading as well. She mainly uses technical analysis to spot support and resistance patterns and gives tips on how you can use technical analysis to spot these patterns yourself.

The book doesn’t just concentrate on the technical side, she also talks about the emotional side of trading. Throughout the book she had regular sessions with a trading coach who tried to look into her reasoning for trading and make her think like a better trader.

There are a variety of other characters in the book such as a director of a CFD company who she calls for advice and other friends who know about trading.

Although not the most exciting book ever written I do think it is worth reading. She talks frankly about many of the mistakes that she makes. You can often learn a lot more from people’s mistakes than what they do right. She keeps making the same mistakes, often related to bad account management.

I personally don’t intend to trade in the same way that she does but I still found her account useful and have made a note of a whole series of things not to do!

Score: 7/10

FTSE 100 CFD Trading: 2nd June 2009

Tuesday, June 2nd, 2009

The day started well with me spotting several trends and managing my risk well. By 2pm I was up 22 points.

Things went wrong after this when the market got more choppy. My biggest loss was in the afternoon around the time that the US housing data was released. The index started moving fast and I tried to profit from the surge upwards. I was too late and bought at the top, it went quickly down losing me 11 points.

The general ‘choppiness’ of the FTSE caught me out several more times in the afternoon. By 3:30pm I was down 10 points.

FTSE 100

Time Price Time Price Profit Running Profit
1 10:56 Buy 4467 11:04 Sell 4468 +1 +1
2 11:09 Buy 4472 12:11 Sell 4479 +7 +8
3 12:44 Sell 4472 12:56 Buy 4475 -3 +5
4 13:19 Sell 4459 13:43 Buy 4442 +17 +22
5 14:42 Buy 4462 14:46 Sell 4453 -9 +13
6 15:00 Buy 4486 15:02 Sell 4475 -11 +2
7 15:05 Buy 4479 15:15 Sell 4469 -10 -8
8 15:25 Buy 4468 15:52 Sell 4466 -2 -10

Lessons learnt.

  1. Trying to join sudden trends is very risky. Slow steady trends are definitely safer.
  2. Trading using a 1 minute chart gives a big risk of false signals. Perhaps I should stick to longer time frames.
  3. Overtrading is expensive as you are paying the spread for each trade – the FTSE spread with the company I use is 2 points. Looking at the overall picture of the day there were two big movements upwards and one large movement downwards. The optimum number of trades for the day would have probably been 3 rather than 8. These things are always easy to say with hindsight!

Due to not having much ‘free’ time the next trading diary entry will probably be in 2-3 weeks.