MONDAY September 5
It’s been a characteristically miserable day in the markets: the S&P/ASX 200 is down 2.2 per cent at lunchtime and the Asian markets are faring worse. The market chat is about miserable US economic data, while the fate of European sovereign debt lurks in the background like a hangover. It’s against this backdrop that I key in my password and log in for a month-long trial on a popular contracts for difference platform. I have $20,000 of mock capital (regrettably, it’s not real) and I’ll paper trade until I think I’ve figured it all out.
I log in to start my month-long CFD trial...
As I log in, my first impression is of a data-heavy page with some regular flashing red and blue lights. Closer inspection shows the flashing is next to buy and sell prices on $A/$US foreign exchange rates, the spot gold price, the FTSE 100 (it’s late in the day and London is in session) and crude oil. I look at the various menus and within seconds realise I need some training.
I also have access to the platform’s training modules and I’ve decided my job for the first few days will be to get through the six-part series before trying even a paper trade. The modules, in PDF form on this platform, are well ordered and filled with examples. The early emphasis tends to be on unfamiliar things such as short positions, which makes sense because most people coming here will have bought shares in the traditional manner beforehand.
In real life, I’d also be making a decision now on whether to pay extra for live data – which depends on just how closely you want to follow the market.
THURSDAY September 8
I’ve gone through the six training modules. A lot of it is about risk management and I like the bluntness of some of the advice: “Do not trade for fun. Do not trade because you are bored. Do not trade because you are scared of missing out.” And, “Leave your ego at the door and admit when you are wrong.”
The CFD trading process seems straightforward. There’s a lot of explanation around stop-losses and I’ve decided I’ll use them (or a limit order) on every trade I make.
In the time I’ve been going through the modules, the world has gone through yet more tortuous ructions: the Swiss central bank has set a ceiling (or floor, depending on which way you look at it) for the Swiss franc against the euro and the fear in world markets now is of a currency war. It doesn’t look good.
...Europe plunges, my $20,000 of equity stands at $36,240. Clearly I’m a genius...
For various reasons tedious and unfortunate, I own a tonne of bank stocks that are a mile underwater. Had I had a CFD account earlier I could have taken a short position against banks to hedge them. It’s too late to insulate those losses but, frankly, it looks like things will get worse before they get better, so I decide to short Macquarie Group (MQG) as a hedge.
The way I see it, if I’m wrong then at least my other bank shares will be rising. Part of me can’t help but feel that this is cutting off my nose to spite my face and that I should just have the courage of my convictions; the other half thinks it’s prudent risk management and if I’d done this ages ago I’d be living in a larger house.
Conducting a trade is simple: type in the stock code, do any research you want to do in another window (charts, Reuters information etc), set the size of your trade, put a stop-loss on if you want to, and press buy or sell. I decide to sell 100 Macquarie shares, worth $2380 or roughly 10 per cent of my opening account.
But I’ve forgotten just how powerful leverage is in a CFD platform. You need only put down a fairly modest amount to effect a major exposure. So having made what, to a usually long-only investor, appears a reasonably significant trade, I notice that I still have $19,992 of funds left and have spent just $87.49.
My initial reaction is: Oh, I should make it a much bigger trade. And then I realise I’ve learned my first lesson about CFDs. The power of leverage is great, amplifying good and bad calls equally, and just because you have the ability to use it doesn’t mean you should.
I leave Macquarie as it is but also decide to short the European market. Nothing in recent weeks has made me think anyone has the faintest idea how to fix the European sovereign debt problems. I think things are going to get worse before they get better.
Again, there’s a logical hedge here. While I don’t own many European stocks I do have lots of stocks that fall when there are global macro-economic worries – indeed, it’s hard to think of any that don’t. So I find, without really thinking about it, that I’m using CFDs as a hedging tool rather than a money-grabbing exercise.
I go to the indices panel and pick the EU 50. I take a bigger position here, and now I’ve used a total of $2000 of margin. Once again I’ve used a stop-loss, so if I’ve understood the system correctly, the trade will close out at a point where my maximum losses are about $4000. While I wouldn’t want to lose that in real life, I comfort myself with the fact that if it happens, then probably my other shares (the ones I really own in this bitter reality) have been going up.
Within seconds, I’m down about $500. I log off and get some work done.
FRIDAY September 9
Next day, I find myself up about $2000. Suitably galvanised, I decide it’s time to try foreign exchange, otherwise known as FX.
Having traded only shares in the past, it takes me a little while to work out which way I ought to be betting (let’s be honest, with forex, it’s all betting) to express my view. I have a theory, you see, and want to try it out: Switzerland’s pegging of the Swiss franc, to support its exporters, is another bit of news that’s not great for the euro. Also, people will be looking for another safe-haven currency if the Swiss franc can’t move. Everyone’s talking about the Singapore dollar, but why not the Aussie? What could be safer and more supported than our very own dollar?
So I take a long position on the Aussie-euro cross rate. I notice that just one lot requires more than $1000 of margin, a reflection of the leverage involved in CFDs. I decide to put my stop-loss in 30 pips below the trade, which means the trade will close if the exchange rate falls from the 76.30¢ where I’ve bought in to less than 76¢. On reflection, I realise that’s probably too close to be sensible in a volatile market – just 0.3¢! But I’m a bit paranoid about the leverage and the potentially bottomless pit of getting my call wrong.
The FX screen is like a ’70s disco: all flashing red and blue lights moving around. All that’s needed is a mirror ball. The FX market moves so exceptionally fast, I can see why most people leave it to the professionals.
...I take my eye off the ball for a few days, and it costs me. I’m back where I started...
MONDAY September 12
After I turn off my computer on Friday, the chief economist at the European Central Bank resigns; the European market reacts as it does to anything with a hint of negativity about it and plunges. When I turn my computer back on, on Monday morning, my short position on European stocks is in profit to the tune of €13,000; I instantly close my position. To my astonishment my $20,000 of equity now stands at $36,240. Clearly I’m a genius.
After this initial moment of euphoria subsides (it is, after all, pretend money) I analyse why I’ve just acted as I have. My view that European markets are going to get worse is considered and, I think, well thought out. It’s a reasonably long-term view. So why have I just closed my position barely two days after opening it? To preserve profits, sure. But if I believed in that position, why not let it run?
I realise I’ve brought some preconceptions to CFDs and am acting accordingly. I’ve read that most people who use CFDs have their positions open for only a couple of days, sometimes even hours, and so I’m behaving the same way. But the truth is, if you’re using a CFD platform for hedging, there’s no reason to do that.
The very next day, I will regret this. Greece defaults and European markets plunge. Pretty much every day for the rest of the week something utterly miserable happens in Europe, culminating with a rogue trader losing $US2 billion of UBS’s money at the end of the week. Had I stuck by my convictions, I’d have made more than twice as much – but, then again, I’m still ahead.
What next? I’m not generally using the platform to buy stocks I hope will go up – it’s easy enough to do that with my usual online broker. The novelty of a CFD is to trade things I can’t normally trade. So next, I decide to take a look at oil.
This particular platform hosts a range of different oil contracts (Brent, US light), in a variety of amounts and durations. I’ve decided that if the world is in a mess, then demand for oil probably will decline, plus the Middle East seems to be a bit calmer, so I take a short position on US light crude. I think about doing something similar with other commodities but can’t decide what I actually think and so, lacking an intelligent reason to trade, I don’t.
Next day, I find that both my FX trade and oil trade moved too far against me and hit stop-losses. I lost a bit, but not too much, and am still well ahead overall. I’ve decided I like stop-losses. In CFDs, putting in a stop-loss also reduces the amount of margin you have to commit.
I’ve been having a think about gold. It’s at a record high and there’s increasingly talk of a bubble. But I don’t see any reason for a decline in the near future. So I go long the spot gold price. This, I promise myself, will be a trade that’s longer in duration. I also go long the Aussie dollar against the US dollar, since it has retreated a bit lately and I can’t really see why.
FRIDAY September 16
Swamped by deadlines, I take my eye off the ball for a few days, and it costs me. Both my trades from Monday – long gold and long Aussie dollars – go against me and hit their stop-loss positions. Worse, I realise I’ve miscalculated the margin on the FX trade and lost twice as much as I thought I would, wiping out the gains on shorting the European sharemarkets. I’m back pretty much where I started.
It’s an expensive mistake, except that it’s not a real trade, and I’m reminded again just how important it is to try paper trading first. Next time, when trading with real money, I won’t make the same miscalculation.
The following week I have to go to America and will rarely be anywhere near the system during trading hours. The only sensible thing to do is to hedge existing positions – which, again, means going short on sharemarkets.
TUESDAY September 27, 2011
My week in America, attending the World Bank/IMF annual meetings, is an apocalyptic series of news conferences and meetings of leaders who are supposed to bring the world away from the threat of recession and euro zone collapse. To say they don’t inspire much confidence is like saying the Titanic had a slightly disappointing maiden voyage. The markets, unimpressed, crash; the Dow loses almost 400 points on the Thursday.
Markets wobble and my stop-losses are too close to my opening level – so I get wiped out.
So with my short positions on world sharemarkets, I must have made a fortune, right? Wrong. Although my call on stockmarkets declining was entirely correct, I manage instead to lose half my money because I failed to take into account volatility. On the way down, markets bounce and wobble and my stop-losses are too close to the level at which I bought – so I get wiped out, despite actually having been right.
Seeing this, I then go short again, with a wider stop-loss, and this time I eventually get it right. By the end of the month, and the end of my four-week trial, I’m just short of where I started.
It takes some kind of incompetence to go short during a market rout and still lose money. But I’ve learned some valuable lessons and am newly convinced of the merits of CFDs. Were I to start from scratch with real money, having learned about the pitfalls, I think I’d do reasonably well.
Since the money isn’t real, I don’t close out the trades on the day I stop trading to file this article. I see what they’re worth that day, take that as my closing balance, and leave them. Two weeks later, out of curiosity, I open the system again. The markets have rallied and all my capital has been wiped out.
Of course this isn’t real, as in reality I would have closed the positions when I wanted the money. But it’s a cautionary tale: never leave your positions unmonitored!