Short-term Trading Pitfalls

Chasing the Trade: Entry or Exit

Entering or exiting a CFD, Forex or Index trade should be straightforward for the short-term trader, however there are instances where it may not be possible to enter/exit a trade at the price the share trader initially believes is possible. Prices can change quickly either way, however the allure of the trade becomes foremost in the trader's mindset, rather than a disciplined approach.

Some of the stocks that are tradable with CFDs may not have the market liquidity and therefore trading volume needed to generate a decent market (volume and the bid/ask spread). Traders 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 volumes 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 volume 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 full margin call from their providers. Rather like storm damage for insurers, these ‘unexpected’ factors are arguably an expected cost of trading. Traders should have a cash buffer built into their trading plan to allow for such ‘unexpected’ contingencies.

Stocks that gap

Gapping on stocks: In Australia the share market is susceptible to a situation where sudden and dramatic overnight price movements on the major overseas markets can be a real problem, in particular the volatile markets such as those related to currency, oil or resources. When trading CFDs or options related to these areas it could be worthwhile to take small positions that won’t adversely harm the trading bank as large unfavourable price movements in the underlying instrument (shares and commodities in particular) can give rise to substantial 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

The onus is really on the CFD share trader to appreciate the risks involved in short-term trading and to adopt a disciplined approach to control them. The key is always to use some form of stop loss. If these are set at appropriate levels then any potential losses should be sustainable. Despite these measures, short-term trading remains high-risk and nobody should trade derivatives unless they fully understand the nature of the transaction and what is at stake.