Recently I have been told about margin trading, and decided to give it a go. However, instead of buying shares with only my money. I trade with CFD, which comes with greater risk, but higher rewards.
I invest into dividend stocks that pay dividend more than what I need to cover the margin loan interest rate, and pocket the difference.
There are risks involved such as margin call when stock price drops to a predetermined level, companies decide to pay less dividend than before, etc.
What is CFD?
CFD stands for Contract for Difference. According to investopedia, a CFD trade pays the difference between buying and selling prices, and enables trader to borrow money to buy shares. For example if I buy at $10 and sell at $11, I will profit $1 per share. However if I buy at $10 and sell at $9, I lose $1.
There are other fees involved when trading CFD, as per below.
- Brokerage fee: this depends on the brokerage platform, normally ranging from 0.01% to 1%, applies to both buying and selling positions.
- Interest rate: the interest rate that trader needs to pay for the margin loan that he or she borrows to trade. The interest rate is predefined in the PDS of the brokerage website, and it can be as cheap as (RBA + 2.5%) to as high as (RBA + 9%) or even higher that I am not aware of.
- Guarantee stop loss fee: in the event of stop loss sell, if the price already moves past the stop loss point, this will ensure that I can still sell the share at that stop loss points. E.g. I buy stock at $10, stop loss is at $8, but the stock drops under $8 before I have a chance to sell. If I pay for the guarantee fee, it will sell the shares for me at $8 instead.
Risks when trading CFD.
I need to take massive risks when trading using CFD.
- Margin call: when the stock falls below a certain threshold, the platform will sell my share automatically to preserve the amount that I borrowed, which basically will crystalize my loss.
- Higher exposure to the market, and higher exposure to loss due to leveraging.
- Noone can time the market correctly, and accurately predict the movement of a company stock.
How do I (potentially) reduce the risks?
- Utilizing an angle of CFD: CFD shares can receive dividend at ex-dividend date. Therefore I do not need to time the market to make profit. In an ideal world, if I buy in a share that pays more than the interest rate, I can pocket the difference without waiting for the share to appreciate in value.
- To prevent margin call, or to lessen the blow if that happens, I place a realistic stop loss level. This will ensure that I do not lose all my capitals, should the price drops too low.
- The mindset is simple, if I trade 10 positions, I just need to win 8, and accept the other 2 as necessary losses.
Let’s talk number
As per the calculations above, with the assumption that the price movement is minimal, we can pocket $402.86 after a year waiting (allocate some of that to pay tax please).
This trade was executed yesterday, and all data you see is the actual figure.
There are a few caveats with this approach.
- Cash reserves to pay interest every day: we need some cash sitting idle to pay interest every day at midnight as the holding cost.
- If stock increases in value, interest is also go up because of the formula that the brokerage service uses to calculate interest amount.
- Not for inexperienced trader, since margin trade requires steel-like mindset, able to follow a pre-defined set of rules.
CFD trading is a high risk form of investment. With a different approach angle, we can significantly reduces the risks. However even with this approach, the risk is still massive and therefore I do not recommend people to follow my method unless they spend some time researching the feasibility of the approach.
Make no mistake, my passion is still with Real estates. This is something that I experiment on the side only.
By Tuan Nguyen