CFDs, otherwise known as contracts for difference, allow one to speculate on the future market movements of the underlying asset, without actually owning or taking physical delivery of the underlying asset. CFDs are leveraged instruments that is usually traded over-the-counter with a securities firm. CFDs are available for a large range of assets. However, in this post, I will only be discussing my experience with CFDs for stocks.
So how does a CFD work? It works similar to a stock. First, you enter into an opening trade with a CFD provider at one price. This creates an open position which you later close out with a reverse trade with the CFD provider at another price. However, the beneficial quality of a CFD is that it allows use to use margin to trade. For me, I could buy CFDs while contributing only 20% of the purchase price. What this means is that the profit is magnified several times. Naturally, the flip side is that losses would be magnified as well. Hence, it is crucial that great caution is exercised while buying and selling CFDs. Let me illustrate this with an example below.
As can be seen from the above example, the profits are magnified by 20x due to the use of margin. However, it is possible for losses to be magnified 20x as well. The commission for trading CFDs is slightly higher than trading normal stocks as well. Nevertheless, the difference is minimal, especially considering the magnification of profits if performed properly.
Having gone through the basics of a CFD, I shall talk abit about my own personal experience with trading CFDs.
YZJ Shipbuilding’s share price had plunged by as much as 20 percent on August 8 due to panic selling stemming from a report that Liu Jianguo, described as a veteran political patron of the shipbuilding industry, was being proved for serious disciplinary violations. In addition, YZJ’s founder and controlling shareholder, Mr Ren had taken leave to focus on assisting in a confidential investigation carried out by PRC governmental authorities. Having evaluated the situation and decided that the panic selling was rather irrational, I bought 10000 YZJ CFDs at a price of 0.94. I then sold them for a profit of 600 dollars a few days later at a price of 0.98. If I had held on longer, my profits may have even multiplied three or four folds. However, I had still managed to make a profit of 600 dollars even though I was only required to put in 1800 dollars as 20% of the total transaction cost.
However, I decided to try trading CFDs again with a different counter, this time Venture Corporation. I bought it at a price of 15.40 around the start of September, and I intended to short sell it as I thought that it would drop in price with the ongoing US-China trade tensions. However, the trade tensions thawed over the next few weeks and my stop-loss position meant that my CFDs were automatically sold. I lost about 600 dollars this time.
From my two experiences, I gleaned some valuable lessons. First, it is close to impossible to time the market, and it should not be done with CFDs which has the potential to magnify the losses. However, trading CFDs can bring in profits if conducted cautiously and without unnecessary emotions clouding one’s judgement. It is important to target CFDs of stocks which have declined in prices due to short-term events which are not likely to result in a sustained decline in prices. The market is irrational after all, and it is to our benefit if we use this to our advantage. However, such opportunities do not come by often, and one should seize the moment once it arises.