I will be sharing with you the 4th and last step of my simple 4 steps formula for achieving success in investment and trading. (For the articles on the first 3 steps for my S-T-P-M formula, you can refer to the previous issue or email a request to [email protected])
This 4th step is about LEVERAGE, i.e. how you can accelerate your return from stock market investment, and how to make your money work harder for you.
The two leverage instruments I will talk about next are CFD and Options. From the survey conducted during Invest Fair Malaysia in 2012, we realised that the percentage of investors in Malaysia who know what CFD is only 7% and even less know about Option (only 3%). This is naturally so because CFD and Option are not yet developed in the Malaysian stock market, or rather our market volume has not been able to support the development of these instruments.
But for those who got to know these instruments and how to use them correctly – it helps them to venture into the international stock market where much more profit opportunities are available, at a much faster pace.
What is CFD?
CFD stands for Contract for Differ- ence, it literally means a contract between 2 parties to trade the price difference of a stock, at a fraction (usually 10%) of the stock price.
For example – person A thinks that Apple stock prices will go up to USD550 within a month’s time and person B, with a different point of view, thinks that Apple stock prices will go down to USD500 within a month’s time.
Through a broker – these two persons can then enter a “contract”. Let’s say the current price of Apple stock is currently USD525 – person A will need to come up with 10% of the stock price, which is USD52.5 per unit of stock. So let’s say in a month’s time the stock price actually went up to USD550, then person A can now close the trade earning a profit of USD25 per unit. His return on investment will be USD25 ÷ USD52.5 that is about 48% in a month!
You can see the effect of leverage here – because if person A were to buy the stock itself at USD525 per unit, then his return will be a mere 4.8% a month (which is still not bad, actually).
Let’s highlight the advantages of trading with CFD: • You can invest in stocks and build
your desired portfolio with less capital. This advantage is useful for younger investors who are just starting out.
• With lower investment (about 10% of stock price), it allows you to diversify with the same amount of capital.
• You can trade on both the upside and the downside of a stock or index. E.g. if you think that the stock price or market is going down, you can shorten the stocks/index (means you sell first at high price and buy back at lower price when the stock/index goes down). That means more opportunities to make profit from the market instead of being constrained to make money only when the market or the stock is bullish.
• It also gives you the opportunity to invest in good stocks that are otherwise too expensive. Many great company’s stocks are expensive. E.g. Google stock price is more than USD700 for 1 unit. In CFD you don’t have to buy in multiple of 100 units (1 lot concept like Malaysia), you can even buy 1 unit or 10 units. However you need to take care of the commission impact for smaller size per trade.
• As a CFD “buyer”, you will earn dividends as well if the stock declares dividends.
• It is very useful as a protection against unexpected market movement, because you can have a mix of stocks that you trade on the upside and downside.
What to take note of when trading with CFD • When you trade CFDs, the
leverage is provided by your broker (just like how banks provide leverage through loans), so you will need to pay interest charges to the broker while you are in the contract. The amount of interest is very reasonable, e.g. it is just about 3% to 4% per annum for U.S. stocks depending on the broker.
• It is critical to trade with strict money management rules. Just because CFD lets you buy a stock at 10% of its price, it doesn’t mean that you can buy the same stock 10 times more, because that means you are not managing your risk properly.
• There are many CFD brokers in the market and the choice depends on your startup capital, market you want to trade, trading style (buy and hold vs. momentum vs. intraday), size of contract and frequency of trades (as it will affect commission). It’s also very important to find a dependable broker in terms of safety of funds and reliability of the trading platform. Some brokers provide mobile access that may be important to you.
• Not all stocks are available in CFD as there needs to be significant demand/interest on those stocks to create a market for it in CFD.
Therefore only the popular stocks and indices are available in CFD. It’s important to only trade CFD for the stocks or indices that has high volume trading.
Whether you are a short-term trader, mid-term trader or a long-term “buy and hold” investor, CFD gives you the leverage to achieve your profit target faster and the ability to diversify with your capital while protecting your investment much more effectively. It is definitely worth learning if long-term success and consistent income stream from the stock market is your goal. There is much more I can share about how I have used them to generate average of 300% returns in the past 2 years and I conduct free seminars from time to time, check out our website www.beyondinsights.net for the next session.
In the next article, we shall share and even more powerful instruments called Options to achieve the P (Protect) and M (Multiply) steps. By knowing both CFD and Options, you can have the power of Hedge Fund Managers to accelerate your returns and protect your portfolio with many more ways than direct stock investment.