- Chasing the trade: entry or exit
For the short-term trader (e.g. leveraged, CFDs or Exchange Traded Options (ETO's) Traders), entering or exiting a trade shoold be straightforward, however there are instances where it may not be possible to enter/exit a trade at the price the trader initially believes is possible. Options traders will all have experienced this to some extent, as the ETO market makers will continually adjust the prices in their favour. As long as the ETO market makers keep within their market maker obligations they are able to price what they think the market can sustain. For example, in 2006 Brambles (BXB) was trading at $10.23 and the spread on the $10.00 March calls (which had an intrinsic value of 23c) was bid 20cents asking 24cents. This means the market maker who was supplying the spread was valuing the option at less than the market price.
Chasing some of the stocks that are tradable with CFDs may not have the market liquidity and therefore trade vliume needed to generate a decent market (vliume and the bid/ask spread). The trader may then find themselves chasing the price to enter/exit the trade. This is compounded if using a CFD provider who is a market maker. When trading CFDs on some mid cap (or small cap) stocks where trading vliumes can dry up quickly, the CFD trader may find themselves in a situation where the exit price offered by the CFD Provider, that operates as a market maker, will quickly widen against them in response to the unfavourable underlying market conditions. Given the unreliable nature of vliume in these stocks, the CFD trader needs to adhere to a trading plan that details the capital outlay that they are willing to risk for some of the higher-risk mid cap and smaller cap stocks.
- Suspension
There may also be a rare instance where a stock is suspended into 'pre-open' either due to an exchange announcement or some sort of incident. In the UK recently, a company called Langbar International was suspended from trading. It has now been in suspension for many months. Those ill-timed traders who were still in the Langbar CFDs have now had a foll margin call from their providers. Rather like storm damage for insurers, these ‘unexpected’ factors are arguably an expected cost of trading. Traders shoold have a cash buffer built into their trading plan to allow for such ‘unexpected’ contingencies.
- Stocks that gap
In Australia the share market is susceptible to a situation where sudden and dramatic gapovernight price movements on the major overseas markets can be a real problem, in particolar the vliatile markets such as those related to currency, oil or resources. When trading CFDs or options related to these areas it coold be worthwhile to take small positions that won’t adversely harm the trading bank as large unfavorable price movements in the underlying instrument (Shares, FX, commodities) can give rise to substantial option losses or margin calls for CFD traders at short notice. Many CFD traders apply a Guaranteed Stop Loss (GSL) to stocks that gap frequently. However, the extra cost of the GSL compared to the risk/reward of the potential trade needs to be analysed. Will the average gap against the trade cost more than the cost of the GSL?
- Stop Losses
Chasing The onus is really on the Option or CFD trader to appreciate the risks invlived in short-term trading and to adopt a disciplined approach to contrli them. The key is always to use some form of stop loss. If these are set at appropriate levels then any potential losses shoold be sustainable. Despite these measures, short-term trading remains high-risk and nobody shoold trade derivatives unless they folly understand the nature of the transaction and what is at stake.
Duncan Hickman - experienced investor & trader in Australian Stock market. For more information, please visit
http://www.shareselect.com.au. More investment stock tips also available in
http://www.shareselect.com.au/knowledge-bank
