Source: Wealth Creator Magazine May/June 2006

CFD Trade example from real Sonray Client trade in Paladin Resources CFD

1. CFD chosen was for Paladin Resources PDN and the price was $2.67. The reason for entry of LONG position was due to the stock breaching its last previous high and a strong surge in Uranium prices accompanying.

2. 100,000 PDN CFDs were purchased for a total amount of $267,000 for which a margin of $26,700 was required. The leverage being 10:1 for this and all Sonray CFDs.

3. The Stop Loss was discussed with the Sonray advisor as a close at $2.59, a price just below the break out and, though a tight stop, one that would limit losses to $8,000. Once the trade moved two days in the positive direction, a Trailing Stop was raised to the original entry price of $2.67.

4. The Break Even price after brokerage for entry and exit was $2.69, given total brokerage for BUY and SELL amounted to $867 plus interest (assume 7.5% per annum) calculated over the period of 20 days at $1,092. NB: Each one cent price rise represents $1,000 profit to the trade.

5. In this case the trader had not determined an exit price except for looking for a 10% gain on the trade upon which the Stop Loss was raised to protect profits already achieved.

6. There were no margin calls in this case.

7 . Trade was closed out by selling 100,000 PDN CFDs at $3.11 after the price had reached $3.30 and began to retreat. Client, in discussion with advisor, determined that a suitable profit had been achieved and an exit was prudent to lock in profits and await another entry signal at a later date for this same stock.

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Margin Lending vs. CFDs

Source: Wealth Creator Magazine May/June 2006

Margin lending vs. CFDs

Private traders are currently experiencing a wealth of financial products that until only recently have been available to Investment Banks and their peers. Over the last few years we have seen the explosion of online trading, derivatives trading, superannuation funds and the ability for the private investors to now be able to access markets that until a few years ago could only be invested in by paying hugely inflated commission rates. Two of the many financial products that have now surfaced are Margin Lending and Contracts for Difference which are also known as CFDs.

What Investors do CFDs and Margin lending suit?

  • Individuals that are aware of the risks associated with gearing.
  • Investors that have high disposable income and are able to meet margin calls.
  • Individuals that have an understanding of the stock market and have considerable investment experience.
  • Trading clients who wish to be more active in managing their trading accounts or super funds.

Margin calls

Both Margin Lending and CFDs are susceptible to margin calls if your investments decrease in value past a certain point. A margin call is the broker’s demand on an investor using a margined product to deposit additional money or shares so that the margin account is brought up to the minimum maintenance margin. Good and dilligent management and conservative gearing levels can minimise this requirement.

Margin lending

Margin Lending is borrowing to invest in a variety of approved shares and funds by using your own shares and cash as collateral. This enables you to not only have access to extra investment capital but also increase your potential growth opportunity which is also known as gearing.

Margin Lending is borrowing to invest in a variety of approved shares using your own shares and cash as collateral.

Most lenders (who predominantly tend to be banks) will offer you anything from 60%-to-80% on the value of your security to purchase shares or managed funds from their approved stock list.

The benefits

  • Enables investors to leverage off their existing positions increasing their earnings potential.
  • For an investor who lacks the funds to do so margin lending provides a flexible solution.
  • With more access to funds it is possible to diversify your investments further increasing your chances of reducing risk within one asset class.
  • Using margin loans as a component in your financial plan gives Investors the opportunity to maximise the after tax returns from their investments.

The risks

  • Not only can gearing increase your earnings potential it also increases your exposure to investments that can fall in value thus accelerating your losses.
  • As with any loan the investor may find it hard to repay if the market falls against them and interest rates are raised.

CFDs

A Contracts for Difference, also commonly known as a CFD, is an equity derivative that allows users to speculate on share price movements, unlike futures contracts they have no fixed expiry date or contract size. Trades are conducted on a margined basis with margins typically starting at 10% for CFDs on leading equities.

Both Margin Lending and CFDs are susceptible to margin calls.

The contracts are subject to a daily financing charge, usually applied at a previously agreed rate above or below interest rate benchmark. Users pay to finance long positions and receive funding on short positions in lieu of deferring sale proceeds. The contracts are settled for the cash differential between the price of the opening and closing trades.

The benefits

  • CFDs make it just as easy to profit from falling markets as rising ones (short selling is the process of selling shares to repurchase them at a later date for less money) plus your provider will pay you interest while the position is open
  • CFDs give increased flexibility over more conventional forms of margin trading
  • You can leverage your money/cash further and expose yourself to greater profits
  • CFDs enable the investor to place a stop loss order on their trades to limit their loss
  • Currently no GST is payable in Australia on CFD trades.

The Risks

  • Due to the power of leverage you can lose more than your initial investment.
  • Financing cost on long positions over time can accrue.

So which product is best?

1. CFDs are short term trading instruments while Margin Lending is more for medium to long term investment strategies.

2. Less risk is associated with Margin Lending. However the stocks that you can invest in are usually on an approved list and less varied.

Less risk is associated with margin lending. However the stocks that you can invest in are usually on an approved list and less varied.

3. CFDs can be used for short selling, Margin Lending does not allow this.

4. Stock can be used for collateral with some CFD providers where they will pay up to 60% of the value of the stock for margin trading purposes. Margin Lenders can give you between 60-to-80% of collateral on your current money and shares.

5. Interest is only paid on open CFD positions if a trade is open. When taking out a Margin Lending Loan, interest is payable on the whole size of the loan whether or not positions are open.

6. Margin loans can lessen the amount of tax payable on invetsments.

7. CFDs tend to carry a lower interest rate component than Margin Lending.

If you are short term trader who likes to short sell and likes flexibility, CFD trading is for you. If you are medium to long term investor who wants to highly leverage your existing portfolio and cash in pre-approved blue chip investments Margin Lending may perhaps be the best option.

Written by:

Doug Picken is a CFD expert with Sonray Capital Markets, a Global provider of CFDs, Equities, Futures, Margin FX and Options. Previously he worked for Man Financial based in London and has been involved in the CFD markets since their inception. Email: d.picken@sonray.com.au