Dispelling the myth behind CFDs

Thursday, 19th January 2017 15:25 - by Ranjeet Singh

Dear Investor,

As somebody who has been trading in the stock market for more than 20 years, I have seen quite a few changes in my time, some good and some bad.

However, the problem is that more often than not, and certainly as a private investor, it’s sometimes difficult to decipher those changes which are largely positive and those which may impact you negatively.

For example, let’s look at the change in terms of the scope of investment products available to the retail market compared to say ten years ago. Certainly, in the last decade we have seen an explosion in this number, which on the surface you would have thought could only be a good thing, right? - Unfortunately not.

Of course, the benefits of having access to a wider selection of investment products in order to manage your wealth are considerable. Greater choice and flexibility means a more accurate and bespoke level of portfolio management and almost certainly at a more cost-effective price due to increased competition. We would all agree that this is positive, but I’m afraid it’s not all good news.

You see, it takes time to really understand a new product when it comes to market for the first time and quite often during this transition period of learning, there is naturally an over-reliance by the investor to seek help from the very professionals who wish to promote their product. And that ladies and gentlemen is the problem because it can, in my humble opinion, be the source of a conflict of interest.

Now I’m not suggesting that this is true for every product or indeed for every professional but there is one product in particular that for me does consistently stand out like a sore thumb. That’s why I have decided to use this opportunity to shine a light on a product that is still so widely misunderstood by the retail investor market that it now baffles and annoys me in equal measure.

If you haven’t already guessed the product that I am referring to, it is of course the dreaded ‘Contracts for Difference’, otherwise more commonly known as a CFD.

Whilst CFDs have been around since the early 1990’s they have really only been popular trading tools over the past few years and whilst you wouldn’t have thought it, these three supposedly innocent letters have had devastating consequences for nearly every investor who has had the misfortune to cross its path.

In nearly all cases previous experiences with CFDs have been so bad that whenever I speak to an investor for the first time, they categorically refuse to have anything to do with CFDs ever again. And whilst I of course encourage them to do what they feel is right for them, I can’t help but feel that it’s such a shame because I know that CFDs if used correctly and if in the right hands are incredibly powerful tools which can enhance any portfolio.

That said, I do also absolutely understand their point of view.

A recent study by the FCA identified that a staggering 82% of investors lost money when dealing with CFDs, and as a result it is now introducing measures to restrict the amount of leverage that brokerage firms can offer. Subsequently the likes of CMC Markets and IG lost as much as 40% of their share value within the following few days that the announcement was made.

To give you a useful perspective I would like to share with you a very insightful analogy that was given to me by one of my clients when he really became familiar with how they worked.

In fact, he said something which resonated with me so strongly that I have used this classic statement ever since because I find it so eloquent.

You see, he viewed a CFD in the same way as a Ferrari; as an incredibly powerful machine that can give great satisfaction and value if used properly but can be a disaster if in the hands of somebody irresponsible.

If the truth be known, I’ve probably spent far too much time thinking of ways in which I could improve upon that analogy but each time I ended up conceding defeat. That’s because his description is absolutely spot on - that’s exactly how you should think of CFDs and thankfully he didn’t copyright his statement and was happy for me to use it. :-)

The fact is that CFDs are both powerful and beautiful but they can also be devastating and horrible. It really depends on who is recommending them to you, for what purpose and the strategy that they intend to employ i.e. whether it’s for speculative or hedging purposes. It’s also important to understand whether your broker is truly recommending them for your benefit or is it to maximise commission for the firm that they work for.

If the motivation of your stock broker or investment manager is legitimate and he or she is offering you the product for the right reasons, then you should have nothing to worry about, provided you understand the risks involved.

Unfortunately, we have seen over the years that this isn’t always the case. That’s why so many CFD brokers have had their licences revoked and why so many more have been fined or suspended.

But fear not because at London Stone Securities we want to dispel the myth surrounding CFDs once and for all.

In fact, it’s so important for me to do this, I’m actually writing a book at the moment called the “13 Insider Trading Secrets that will Blow your mind” and this is one of the secrets that I will be exposing.

For too long I think private investors like yourself have been given the rough end of the deal and I like to think that in some small way I’m going to be able to even things up for you. If I can show you what I know happens on the ‘inside’, I hope it will give you a little more ammunition and protection against those few unscrupulous firms who continue to do things (in my opinion) the wrong way.

I may not be too popular by everybody in the City after this book is published but thankfully I never joined this profession to win any popularity contests. To the contrary my approach has always been pretty simple - I’ve always favoured an honest and transparent approach both in my business and my personal life and so I guess this is simply a continuation of that.

Everything is going well; my book will be published in the not too distant future and possibly by the end of the year (yes writing a book as I have found out can be painfully slow). However, if you cannot wait that long and really want to know what’s going on with CFDs and the pitfalls that you should avoid, then feel free to contact me at rsingh@londonstonesecurities.co.uk. In the meantime, do be careful driving that Ferrari. :-) 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.