Is CFD trading a sophisticated form of gambling?

Understand the dangers of trading CFDs before jumping on board

If you are involved in trading Contracts for difference (CFDs) and you read the papers, then you would have come across a number of CFD articles suggesting that trading CFDs is just like gambling. In this article we'll take a look at the reasons behind such an damning reference and explain clearly how to 'remove the gambling' in your CFD trading.

Las Vegas & the rich and famous

When people think of gambling, visions of Las Vegas, roulette tables and the rich and famous come to mind. Next you have the horse races and events like the Melbourne Cup which literally stops the nation and over $250 Million is invested (aka gambled) on this one race alone.

Yes Australian’s love to gamble and recent reports indicate that 80% of Australian’s gamble which represents the highest rate of gamblers per capita in the world! Australia also wins the title for the most poker machines per capita in the world. We sure are off to a flying start aren’t we?

For many years seminar spruikers have indicated that Australian’s are the largest owners of shares per capita in the world and most recently CFDs have literally exploded on our market. It seems to be true that Australian’s love shares and have taken to CFDs like Tiger Woods to the fairways and knee surgery.

Time to trade your Holden for a Porsche

The people who suggest trading CFDs is like gambling, usually come from a history of long term stock investing where solid blue chip companies paying attractive dividends rule the portfolio. Many traders would suggest going from trading stocks to trading CFDs is like trading in your Holden Barina for a twin turbo Porsche 911. If you are an inexperienced driver, then jumping behind the wheel of a high performance car could be deadly, just like those trading CFDs with little to no experience.

Stock Markets worst result in 26 years

If we stop to consider the recent market correction, which experts have identified as the worst yearly performance of the Australian All Ordinaries index in some 26 years, can we even be safe investing in solid blue chip companies like National Australia Bank, AMP or ANZ bank? Many Self managed super funds and accounts of investors holding on to these ‘Blue chips’ have lost anywhere from 15-45% since their November 2007 highs. Calling the buy and hold strategy gambling would be a large mistake on my behalf because without knowing the time frame or risk tolerance of the investor would mean I’m just making a huge generalised statement.

So too with CFDs in that calling CFD trading gambling without knowing how the product can be safely used, the trader or investors time frame and risk tolerance then this statement too would be a huge generalised statement.

So why do people consider CFDs to be gambling?

First and foremost the biggest offender is the fact that you can lose more than what you start with when trading CFDs. For example you might have $5,000 in your CFD account but your CFD Leverage will allow you to trade $100,000+ worth of most blue chip shares like BHP.

If BHP falls 6% in a couple of days or perhaps even in one day as it did in January 2008 (gapped over 6% overnight) then you would have lost around $6,000. Considering you only have $5,000 in your account you now face a small problem.

You’ve just wiped out your trading account and now owe $1,000!

So not only are CFDs dangerous in the wrong hands but it’s actually worse than gambling because you can in fact lose more than what you start with. At least when you journey off in your finest suit or beautiful dress to the race track, the most you can lose is the money you start with.

So yes, when people trade Contracts for Difference (CFDs) with reckless abandon and don’t take into consideration how to effectively use their CFD leverage then problems can arise and CFDs can take on a gambling like nature.

Having said that those who can control their CFD leverage, understand appropriate risk management, use stop losses religiously seem to have advantages that go far beyond the basic stock trading.

How to make 30% returns without breaking the bank

Let’s say you have backtested your trading system and it returns 10% per annum with no leverage. Not exactly an incredible trading system and certainly won’t win you portfolio manager of the year but nonetheless a sensible plan to extract steady profits from the market.

What happens if you then trade that at 3 times leverage? This means if you start with $10,000 cash in your CFD account, you take positions that do not exceed more than $30,000 in total. You then continue trading your 10% return per annum system and voila you have now achieved a return of around 30% on your cash.

You just made 10% on $30,000 which is a 30% return
on your cash outlay of $10,000.

So the real trick to trading Contracts for Difference (CFDs) is controlling your leverage and understanding your CFD Risks implicitly. In fact it is sensible to trade CFDs with little to no leverage whilst youare finding your 'feet' in the market.

So before you put down the deposit on that princess motor yacht, start very small and trade well within your limits. Any investment carries risk but successful traders and investors understand that risk is essential in order to earn a reward for their efforts.

How to remove the ‘gambling’ from your CFD trading

• Start small - open an account with $5,000 or less;
• Develop a trading plan that suits your investment / trading profile; 
• Identify your entries, exits and use appropriate risk management; 
• Commit to taking the first 20 trades your system generates with very small risk on each trade (1% risk of trading capital maximum); 
• Identify if your trading system has an edge and is worth continuing to trade; and 
• Continue trading or re-evaluate your trading system 

Overcoming Fear and Greed

Countless Trading books have been written on overcoming the psychological aspect of trading the markets. Overcoming Fear and Greed are by far the most important aspects to long term success and greed alone is usually what drives people to gamble when trading Contracts for Difference.

Greed in CFDs is disastrous and can definitely have the potential to wipe out your trading account and then some if you are not careful, but then again greed in most financial instruments will cripple your long term wealth creation plans.

The problem with CFDs is the easy access to trading platforms either online, over the phone or direct through your mobile phone. Couple this with the incredible leverage you get access to (from 10 to 100 times your starting balance) and you can see why greed can be the silent and willing killer to any trading account.

"Contracts for Difference (CFDs), Forex, Options or Futures are not risky,
it's how the trader uses them that makes them risky or not."

Having watched many traders succumb to the greed of high returns through trading it has become clear that controlling the amount of leverage you trade with in your CFD account is paramount. Risk is very closely correlated to return so play it safe, keep the leverage on your CFD Trading to a minimum, trade your system confidently and enjoy a long and rewarding association with trading Contracts for Difference.

Trade Smart.

Ashley Jessen
LearnCFDs.com

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Disclaimer: Trading Contracts for Difference carry risk where you can lose more than what you start with. View our full disclaimer here.

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