CFDs no quick-fix for market losers, warns BJM PCS

Retail investors suffering equity losses should avoid a casino mentality by using tools like contracts for differences (CFDs) to get their money back.

The alert comes from Barnard Jacobs Mellet Private Client Services (BJM PCS), a leading wealth manager and stock-broker with dedicated focus on the needs of high net worth individuals.

BJM PCS offers a free CFD trading platform to clients and believes these instruments have a growing role in a more volatile market prone to periods of weakness – but is worried in case some investors make ill-advised use of this relatively new tool.

“Emotional reactions have to be avoided,” notes Hobs Mojalefa, head of dealing at BJM PCS. “Studied, well-informed purchases and sales of CFDs as an essentially defensive tool in a wider strategy often makes a lot of sense.

“But simplistic use of CFDs as a quick-fix has the potential to multiply your losses. A cool head, a strategic approach and professional advice are required.”

A CFD is a geared over-the-counter product. The contract is a proxy for direct ownership of JSE shares. A key benefit is leveraged exposure to the equity market at lower cost than direct share dealings. Gearing (using borrowed money to multiply potential gains) can be as low as 8%, but might be much higher.

Gearing can multiply losses as well as gains, however.

One CFD strategy is to take a contract that ‘shorts’ an underlying security. In effect, the contract owner ‘borrows’ a share and ‘sells’ it, with the view that the underlying price will fall so he can buy it back, return it and pocket the difference.

The strategy attracts added attention when markets falter, as they have in recent weeks. For example, at one stage in late January the JSE had fallen 16% from its record October highs.

Hobs Mojalefa notes: “BJM provides a CFD trading service to clients, but these are usually seasoned and sophisticated traders and short term market players

“We don’t just offer a transactional service; we back it up with advice, up-to-the-minute research and other information. Clients can however use CFDs as a cost-efficient way of balancing their positions and or protecting downside risk to their portfolio’s.

“Since mid-2007 we have seen trading volumes across this platform triple. One reason was that we advised clients that some downside risks were growing. This is very different from a knee-jerk reaction to a recent loss, gambling that you might make your money back. Using the top 40 Index as a tool to hedging the overall portfolio is often complex as the underlying portfolio is normally not directly comparable to the Top40 index. It is therefore advisable to hedge specific counters/shares within ones overall portfolio.

“Good advice amplifies the value of a good platform. Using CFDs as a bet means you are using them as casino chips when you should be using them as a strategic tool in a well-informed strategy.”