News

CFDs - Friend or Foe? 

HomeTrader Media Release 21 May 2008

The Australian share market is experiencing a new era caused by the rapid growth in the use of leverage, especially by less sophisticated market participants.  Coupled with recent share market volatility, this could be a deadly cocktail.

Risk management is more important today than ever before according to HomeTrader Executive Director and successful share trader, Jason Davis.

The leverage revolution began when futures became available to the retail trader, then options, warrants and more recently CFDs.  The ability to amplify returns is an attractive draw-card for traders but as the bull market surged ahead, many traders forgot that risk is not exempt from this amplifying effect.

“Traders are drawn to leveraged products like bees to honey.  CFDs are the most recent example of this.  Since their introduction in Australia in 2002, traders have consumed CFDs with an insatiable appetite,” said Davis.

The January share market free-fall over 11 consecutive days spelt the end for some traders who leveraged themselves into the market with disregard for even basic risk management.  The record number of margin calls by CFD providers was evidence of the frightening position many traders found themselves in.

“With interest rates rising, speculation of a US recession and the share market bouncing around, a passive observer could be excused for thinking that making money trading shares is not a good option at the moment.  Ironically, the volatility in the share market is a valuable opportunity to make money as long as you have a smart and tested trading strategy,” said Davis.

“My short term system trading CFD results have performed better in the last four months during this volatile time, than in the last 12 months.  The market correction over the past four months is a very good example where rigid risk management was needed to protect capital and minimise losses,” said Davis.

HomeTrader is one of Australia’s largest financial market educators and has taught thousands of Australians how to make money trading shares and CFDs.  Risk is the corner stone of HomeTrader’s training philosophy.

Risk management is not just about having a stop loss in the market.  According to Davis the solution is a complete risk management plan, coupled with a defined strategy that has a profitable bias.

Davis explains that the most basic principal of risk management for a trader is to understand how much you can afford to risk in relation to your trading capital and adjust your position size such that even in the event of a stop loss breech, the dollar loss will not exceed the risk amount. Secondly, even the best risk management will not work long term if a trader doesn’t have a trading strategy that has a positive expectation to produce profit.

“Unfortunately many don’t invest in education before embarking into the world of trading and find themselves making mistakes that can cost them their entire account,” said Davis.

“I wouldn’t read a book to learn how to become a doctor.  The same principle needs to be applied to share trading.  People need to realise that trading is a profession that requires study, especially if leverage is used.”

“The best thing a new trader can do is invest in training courses to ensure they have the skills to keep them afloat during times like these.  Don’t fall into the trap of being an emotional share trader who sells at the bottom of the market because you get nervous, instead, be a smart trader and make money using risk management rules,” Davis concluded.