Sunday, 12 May 2013

Contracts For Difference


A long time ago I used to not be into medicine at all, and was in fact well and truly obsessed with contracts for difference (CFDs). Why were you so obsessed with them, I hear you ask? Well, it's pretty simple. Basically, trading a CFD is the same as trading a share, except for the same change in price in the underlying security you make either a much greater loss or a much higher profit. For example, the other day I was trading USD/AUD with a leverage of about 99.75%. Normal share trading you can think of, for the purposes of comparison, as a CFD with a leverage of 0%. What you get is what you can pay for. With the CFD I was trading the other day, I was only having to come up with 0.25% of the total value of the goods I was trading. Now when something increases in price by $2, if you buy at the bottom price and sell at the top price you only get $2 for every share you were able to buy. If I was to buy that without using CFDs, I might only be able to buy a few hundred of those shares because my money isn't being leveraged. However, if I was to buy with a CFD I could leverage my money and have the buying power of say $10000, without actually having anywhere near that amount. Now I can buy many more than a few hundred of those shares, and so even though the price difference is still just $2 I am now making a much grander profit. 

The downside to this of course is that if it had gone down $2, I could have just put my family into bankruptcy (quite literally -- leverage can be extremely powerful in CFDs, such as my 99.75% example above). At the moment I use extremely tight stop losses (automatic levels that you set where, if the share trades at that value, it automatically sells them for you, to 'stop' your 'loss' hence the name) and I only trade in small amounts. However, it's still easy to see how powerful these things are: I think I traded 2 units of gold, which I needed to put I think $6 on the line for (that's instead of having to put out about $3000 to have 2 ounces of gold...). The share price went the way I thought it would, and I took a profit pretty quickly, and the profit ended up being $10. That's $10 above my $6, so by the end I had $16 on top of my reserve cash. Now, you're probably thinking 'so what, that's $10, who cares!' but think about this: that ends up being a 167% profit. Now, change my $6 into $6000, and all of a sudden out of that small price movement I've made a clear $10000. $6000 usually would only have bought me about 4 ounces of gold if I had no leverage, so my profit would have only been about $20 ($5 per ounce, because before I owned 2 ounces and made $10). You can clearly see that a $20 profit after putting $6000 on the line is not quite as good as a $10000 profit for putting the same amount of money on the line.

So, if there's so much profit to be made out there by the calm and logical investor, why didn't I go into it! Well, I read a very wise share trader once say that to be a day trader you can't do it on the side -- it has to replace a job. It takes a lot of time to watch the markets, and be in a position of knowledge about the share price, rather than guessing where you think it's going to go. At the time when I was thinking about going into CFDs in a big way, I just couldn't see myself sitting at a computer all day as being much fun. And if it really did happen in a big way for me, if I retired in a couple of years with a billion dollars in my pocket (my dreams were big, ok) then what? There's only so much you can sit on a beach sipping cocktails! At that time as well I was getting veeeery interested in medicine, so I decided that I would give medicine a go and see where it takes me. Of course my attitude to medicine is now very different -- even if I could be guaranteed of billions in CFDs I wouldn't stop pursuing medicine -- and I'm very glad that I decided to not go into CFDs.

As mentioned though, I have been doing the odd trade here and there recently, and as long as I don't put much money into it it could be just a nice distraction. I intend to set up a trade in the morning, and not touching it again until the evening, seeing what happened with it and learning about what went wrong for about 5 minutes. If it could be a nice little earner on the side as I go through these next years then that would be pretty nice!


No comments:

Post a Comment