THE SUREST WAY to profit from a downtrend in stocks is to have the foresight to sell out all your investments early, and buy at the bottom just before the market trades up.
With the introduction of Contracts for Difference (CFD), it is time for investors to shift away from the mindset that profits can only be made in a market uptrend.
The fact is if you are bearish on a stock, you can use 'short' CFD.
Shorting allows you to sell a stock at a high price and buy back at a lower price. Profit is made from a fall in the share price.
A CFD short position can be held indefinitely, unlike a 'naked' short in the cash market which must be covered back within the same day or the trader risks being slapped with hefty fines by the Exchange.
The short-selling feature is only half the story. You can also use CFD to go ‘long’ – ie, buy a stock and sell it later at a higher price.
CFD allows you to leverage up to 10 times your deposit - for example, to buy $30,000 worth of Capitaland, your CFD account needs to be funded for $3,000. If Capitaland moves in your favour, the unrealised profit is immediately credited to your account, and vice versa.
The use of leverage cuts both ways: It will magnify your gains – and losses.
To find out more, we spoke with Kenneth Toh, 40, a dealer with Kim Eng Securities:
Q: When did you start with CFD?
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Kenneth: Kim Eng Securities launched CFD in August 2008 – a most timely event as the Lehman crisis broke out the following month and the markets went down for a protracted period.
This was a time where the shorting power of CFD was well demonstrated.
Q: Do people hold short CFD positions for a long period of time?
Kenneth: The stock market is inherently long-biased, so nobody invests long term by going short. They go short only to take advantage of negative knee-jerk reactions in the market. Clients typically cover their shorts in a matter of days or weeks as soon the stock turns upward.
Q: What trades stand out in your recollection?
Kenneth: An example is Chartered Semiconductor. A local newspaper reported a rumour in May 2009 that it might be privatised. A client of mine went long and held the position until September when the news did become official.
I can't remember the exact figures but he had about $200,000 in deposit. If he had leveraged 5X, he would have opened a $1-million trade position, or bought 500 lots of the stock at $2.
He sold at around $2.50. That’s $250,000 in gross profit, more than a 100% return on his initial capital of $200,000.
Q: To balance the picture, can you cite a loss-making trade?
Kenneth: There are plenty of examples during this extremely volatile period. The market whipsaw has made it difficult to go long or short. My clients are cautious and are only leveraged about 2 times.
Q: Is there a category of people who would find CFD especially interesting?
Kenneth: One category would be contra stock players. In a cash market, they have only five days to contra before they must up up 100% collateral. But using CFD, they put down a minimum of 10% margin and can hold the position indefinitely. Kim Eng Securities doesn't charge rollover fees.
The other category would be those who want to hedge their existing cash stock portfolio against any downside.
If the market turns bearish, any losses incurred from the long positions in their cash account can be offset by the profit from the corresponding 'short' positions in their CFD account.
Q: There are two CFD models – Direct Market Access and Market Maker. Why should a client consider DMA?
Kenneth: In DMA model, the prices you see on a CFD platform are the same as that in the stock market. If the highest bidder for Genting is queuing to buy 1 million at $1, you will be able to see this and you can sell directly to this bidder.
Execution-wise, it is as good as trading the stock. There is transparency.
However, in the other model where a market maker is involved, the order fulfillment is at the market maker's discretion. Your order to sell directly to the bidder might not get done. And the prices and volume shown might not be the same as the stock market.
Q: What are some of the risks of CFD that you are mindful of?
Kenneth: You can lose more than your invested capital as is the case with any leveraged instrument such as the stock margin account.
If you deposit $3,000 and fully leverage to buy $30,000 worth of Genting - say, 30 lots at $1 - the stock only has to go down to $0.90 and you would have lost $3,000 already. Risk management is key.
