Friday, October 2, 2009

CFD - Certificate For Death

I read this article from IMSavvy's website. I am pretty adverse to using leveraging to buy shares. Contracts For Difference might only work for some people. For others, it might just become a Certificate For Death (CFD).

Pasting the article written by Goh Eng Yeow (with what i think some newbie investor might be thinking about when they read this article in RED):

GAINING exposure to a blue-chip company need not mean buying its pricey shares listed on the Singapore Exchange (SGX). Really? You mean there is another method? I am a beginner in investing...let me know..anyway this IMSavvy website is designed to increase our financial knowledge right?

Investors are making a beeline for an increasingly popular financial derivative product known as Contracts for Difference (CFDs), which enable them to 'own' these blue chips without having to stump up the full price of the stock. Wow. So you mean i can buy shares like DBS. Cool!

Brokerages jostling for a slice of the action include local houses such as Phillip Securities, CIMB-GK Securities and Kim Eng Securities and foreign outfits like IG Markets, Saxo Capital and CMC Markets. Good..think maybe i should open an account with one of these brokerages..

A CFD works like a share margin trading account. When an investor buys a CFD on a blue chip like DBS Group Holdings, he need put up just 10 per cent of the cost of owning the stock. Wah! DBS 13.00 means i only need 1.30. Shiok!!
The CFD tracks the share movements. If the price goes up 10 per cent, he would have doubled his initial outlay. But if the price drops, he will have to top up the account with more cash, or risk having his contract sold by his broker to settle the loss. Wah Double My MONEY!!!

CFDs are not traded on the SGX. Unlike warrants, for instance, they have no maturity date and an investor can cash out at any time. So good ah? Like that buy shares for what. I going to buy CFD liao

They are popular because investors can immediately track their gains or losses by glancing at the prices of the shares whose CFDs they have bought.

This is unlike covered warrants whose prices are determined by a complicated formula relating to factors like 'time-decay' - the remaining months left in the contract - and market volatility.
The range of assets linked to CFDs also goes far beyond the Singapore market.
Besides trading local blue chips, an investor can trade foreign currencies like the US dollar, commodities like crude oil, as well as widely watched indexes like the Straits Times Index and the Hang Seng.

For some CFD players, business growth has been phenomenal. 'Since 2007, the number of accounts opened has doubled every year. Currently, we have about 11,000 accounts,' said IG Markets managing director Peter McDermott.

His typical customer is a working professional aged between 25 and 55. About 40 per cent use CFDs to trade foreign currencies; another 35 per cent trade shares.

Given the market volatility in the past two years, trading in widely watched indexes such as the Straits Times Index and the Hang Seng has also become popular.

Drawing a parallel with London, where CFDs form about 35 per cent of all trades, Mr McDermott believes the local CFD market can grow further.

But this will not necessarily result in a loss of business for the SGX, as CFD players would have to 'hedge' their risks by buying the underlying shares of the CFD on the SGX.

Still, CFDs pose a big threat to the 'extended settlement' (ES) contracts which have been offered by the SGX since February and work on a similar principle.

A stockbroking director said remisiers prefer to sell CFDs, rather than ES contracts, as there are fewer administrative hassles, saying: 'With ES, you have onerous account opening requirements and the margin requirements are stringent.'

Some traders complain that only a few hundred thousand ES contracts are traded daily and investors are put off by the lack of liquidity. 'With a CFD, the spread between a buy and sell quote may be as small as one cent. But with an ES, it can be as wide as two or three cents. That increases the trading costs sharply,' a dealer said.
Okay.. Tomorrow i go open account CFD for DBS..lalalala HUAT HUAT loh!
Good luck to all who get into this financial instrument. Certainly not for the faint hearted and not for the newbie investor.
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  1. There are no shortcuts to building wealth. If we wish to own a share of DBS (trading at $12.80 now) and only stump up $1.28, this means we are on 90% leverage. Should the share price fall sharply and trigger a margin call, you may lose more than 100% as you were using CFD borrowed money to own a blue chip.

    That's why I do not encourage leverage. Invest only with money you have.


  2. Leverage is great if you know how to use it. I am also not a really big fan of leverage trading but leverage investing with a medium to long time frame is great for creating wealth. I do agree that CFDs in the wrong hands is a death trap for many people.

  3. Yep. Just remembered that Rich Dad Poor Dad says that we should not fear leverage but instead respect it.

    Good debt is better than bad debt.


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