Lacey: Let's say I'm new to the market. How much do I need to open an account and run a portfolio effectively using these products?
Todd Crosland, Interbank FX: Our initial minimum deposits are $250 for a mini account and $2500 for a standard account.
Richard Miller, Barclays Stockbrokers: There isn't a minimum for a Barclays CFD account, but you are charged a commission and therefore there is an efficient trade size - there's no point trading a £100 position when we charge £17.50 minimum commission. It's up to you how big a position you want to take but the efficiency level is probably well above £1,000.
Jon Scott, E*Trade: An E*Trade Professional account has a minimum opening balance of £5,000.
Tom Hougaard, City Index: Those who are new to spread betting can go for a demonstration account to get a feel for it. Or they can risk a couple of hundred pounds on what we call a limited risk account. Essentially this means you will not be able to lose any more money than you put into the account. It's a good way to start out as you get exposure to the financial market and experience in trading.
Lacey: If they start to get interested, they may decide to risk a fair bit more.
Hougaard: Yes, they do. From a personal point of view, I always have £10,000 in a spread betting account. It might not seem like a lot in the scheme of things but when I trade currencies that gives me a couple of hundred thousand pounds worth of buying power.
Lacey: It also depends on the markets you are going to trade, doesn't it?
Hougaard: Exactly - £10,000 in the oil market could get you into some serious business.
Lacey: What margin range or level of gearing normally applies to these products?
Hougaard: With the spread betting industry, there are three levels of margin - on stocks, on indices and on currencies. Currencies attract the lowest level of margin, or the most firepower if you like - generally between 1% and 2%, which means you've got between 50 and 100 times gearing. Indices are generally 5% and the margin on stocks 10%.
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Lacey: And the same kind of levels on CFDs?
Scott: We hold out variable margin. The margin offered goes up as the perceived risk of the underlying instrument increases. This is based on on market capitalisation, liquidity and volatility. Where you have a FTSE 100 stock, you could get between 5% and 10%. Where you've got a smaller company with less liquid stock, you would be looking at anything between 25% and 100% on margin.
Miller: These margin levels have been set for a reason and are to do with the volatility of the underlying investment. Although 2% on currency sounds risky, a 2% movement in currency is actually quite big, just as 10% in a stock would be a big movement. But even though we provide some nice levels of margin, clients don't have to take full advantage of that if they don't want to. Even though there's 10% margin on your average FTSE 100 stock, that doesn't mean a client with £1,000 in his account should immediately take out a £10,000 position. You've got to use this product responsibly to make the most of it.
Lacey: What about forex?
Crosland: The trader can ultimately choose his leverage up to 200:1 on a mini account or 100:1 on a standard account.
Lacey: Let's say I have half a million in liquid assets, I own a house, I haven't got any financial problems and I'm working. What proportion of that would it be sensible for me to risk in your products?
Crosland: As far as it relates to a forex account, we actually recommend that traders have only 5% of their equity tied up in a trade at any one time. Because you are trading on margin, you can run into serious issues if you over-leverage your account.
Miller: It's not so much the amount you put into the product, it's how much you are allocating to each individual trade and each piece of exposure you have.
Lacey: So you don't treat the product as an asset class, merely the access to the asset class?
As long as you are aware of how margin works, there is no need for a trade to be riskier than it is with any other product
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Miller: That's correct. Some people might feel comfortable allocating 10% or 20% of their total liquid assets to a certain product but it's altering the positions after that which is ultimately your exposure.
Hougaard: It depends somewhat on your age. If half a million were my total net worth at the age of 70, I would be less inclined to consider spread betting as a source of revenue than I would at 35. Also, if I were someone who had a relatively scant relationship with the financial markets, the first thing I would do would be to put the money in a bank account and get myself some education on the market.
Dan Moczulski, IG Index: Everybody's circumstances will be different. Perhaps we'd all agree that the best way is to think of a number and halve it. If you are hugely successful, then fantastic - that's when you bring the rest of the money into play. But when you are starting to learn about how financial markets and different products work, always think small.
Lacey: Do you think people coming in for the first time tend to overestimate the return they can make on trading?
Hougaard: Yes! A typical example is someone who has a £50,000 lump sum and is looking to make a comfortable living from the return. A comfortable living in the UK is, say, £25,000 - that's 50% a year and Warren Buffett would be pushed to make that, although he is perceived to be the best in the world.
Miller: But we can't ignore the fact that you can make very good returns using these instruments. That's the whole point of derivatives.
Moczulski: Although I agree with Tom's reservations, a 50% return on investments would only need a 5% increase in the underlying with products on 10% gearing, so I am not quite as dismissive of the possibility of trading for a living with CFDs and spread bets.
Lacey: Using stop losses effectively is sometimes easier said than done
Miller: Yes, it's often easier to get into a position than out of it. The successful investor or trader will be the one who exits at the right time and use of the stop order is a fine art. Those who can get it right will make very good money.
Moczulski: It's a common complaint when the markets gone down and rebounded that the investor would have made a profit if it hadn't been for the stop loss. I would recommend if you are going to use a stop loss to set it at a point where, if the market goes to that level, you are delighted to be out. It should not be a way of risking the least amount of money. If this is of major concern to anybody, perhaps they'll look at binary bets or options because these are limited in risk and don't have stops that can be triggered.
Crosland: We really strive to give the customers control of their trades. Our platform also offers trailing stops, the ability to modify top losses and take profits and the ability to send pending orders complete with their own stops and take profits).
Lacey: In your various educational sessions, do you suggest ratio of winning trades to losing trades?
Moczulsk: Not necessarily - it's your overall profit or loss that matters. If your strategy gives you nine losses in every ten but the one in ten easily outweighs those you lost on, that's a fantastic trading strategy. What you are looking for is a strategy that gives you discipline so that you can trade in a profitable manner.
It's strange to say but one of the worst things that can happen to a new client is that they make money on the first two or three trades and think they are invincible.
Their trades get bigger and bigger and they don't adequately look at the downside, whereas somebody who slowly gets into the market, makes a couple of losses, makes a couple of profits, is far more aware of how the products work.
Lacey: Let's look at the range of markets I can trade using your products.
Miller: On UK shares, Barclays Stockbrokers CFDs cover all the stocks over £50 million market cap, plus US and European shares of $500 million or €500 million. We also offer access to UK sector indices, so you trade pharmaceuticals or the banking sector, say. We offer the top 12 currency pairs, the top 12 equity indices, plus gold and silver.
Scott: E*Trade CFDs give you direct market access to 11 international exchanges including the NYSE, Nasdaq, LSE, Euronext & Deutsche Börse, plus Index CFDs. The best way to find out the full extent of our offering is to visit our website at www.etrade.com.
Crosland: At the moment at Interbank FX we have 19 currency pairs available. We are adding another ten pairs shortly as well as metals.
Moczulski: With IG you can trade any UK stock with a market cap of more than £10 million, US stocks with a cap of over half a billion and a huge array of Asian and European stocks. We offer more than 40 indices contracts, over 50 cross-currency rate contracts, more than ten interest rate contracts and over 50 commodity contracts. All these are offered as options as well.
Hougaard: At City we offer equities, currencies, commodities, as well as sub-sectors in the FTSE. The most popular bets we've had, surpassing our traditional top bets of the Dow and FTSE, have been these sub-sectors, particularly the mining sector.
Lacey: Are all the possible trades on your platforms or is it possible to ring up and ask for, say, a CFD on a sub-£50 million stock?
Miller: Yes, we can quote on instruments which are less liquid.
Lacey: Would you then go to the markets and hedge that?
Miller: This is something which would be more likely in a very liquid stock.
Lacey: So my trade could affect the share price?
Miller: It could well do. Even though you are not hitting the stock market every time, CFD and spread betting trades do get hedged in the real market.
Hougaard: A lot of the spread betting and CFD trading platforms offer virtually guaranteed execution. So the minute you click that buy or sell button, you can be guaranteed in 99.9% of cases that you will be filled at that price. But if someone comes and buys £100,000 in a small stock that is trading at 2p, I am not sure that I could guarantee execution at that price. So 98% of everything is available on the trading platform but not those which have a liquidity problem.
Moczulski: It has to be cost-effective for us but so long as there is going to be interest and we can hedge, there is no reason why we can't quote any market that you'd like. If you were to look back three years at the spread betting industry, the range of shares you could trade would probably be half what it is now. That is simply because clients have asked to trade these shares.
Lacey: So if I wanted to go into orange juice futures and you haven't got it on the platform, you'd look at it for me?
Moczulski: Absolutely. Last year we became one of the major drivers of Malaysian palm oil, simply because a client wanted to trade that market.
Lacey: Most people going into a trade are essentially looking to make money reasonably quickly. But there are other things that you can use the products for, such as hedging strategies, aren't there?
Scott: Yes. Predominantly traders are using them speculatively but the CFD is an efficient hedging tool as well. If you have an underlying portfolio and you want to lock in the profit, you can short the CFD. With a flat-rate CFD, it's cost-efficient and effective.
Lacey: Also, if you want to sell but don't want to dispose of the stock itself...
Scott: You continue to lock in your voting rights and so on and still have that comfort of price.
Hougaard: And with a CFD any loss can be offset against capital gains tax, which doesn't happen with a spread bet.
Scott: And if you short the CFD, you receive interest.
Moczulski: For those not familiar with hedging, a lovely market to demonstrate this is the house price market. IG Index provides a bet on the HBOS house price index. Two or three years ago, a lot of people were concerned about the value of their property falling so bet that house prices would come down, the theory being that they would lose money on their own home but would make it back through the spread bet. If house prices rose, they would lose money on the spread bet but their house would have appreciated to cover it.
Miller: You can also use CFDs for pairs trading, which is speculative while also keeping risk quite low. The way this works is you pick two stocks which are very similar to each other, such as BT and Vodafone, buying one and selling the other. You are taking a view on the comparative differences in the movement of the price.
If you think BT is going to outperform Vodafone, buy BT and sell Vodafone, so you are trading the difference between the two, which is actually quite low. If the market shoots up, you gain on your long and lose on the short, and the opposite if the market falls. You can do that with sectors as well.
Moczulski: What you are doing here is eliminating industry risk. Taking the airline industry as a topical example, if you considered British Airways to be a better-run firm than Ryanair, you may operate a pairs trade. What is currently happening in airports would not affect your trade because you would be speculating that British Airways wouldn't go down as much as Ryanair.
Crosland: Our product offering is somewhat unique in that we provide a variety of tools that allow the customer to manage his or her risk, such as the ability to hedge their trades (essentially taking both sides of the same trade), trailing stops, wireless trading and a variety of lot sizes. This is particularly important to the newer traders. They can trade a 'micro lot', which essentially has a notional value of $100 and translates to a pip value of 0.01 USD.
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Lacey: Assuming I'm a total innocent in this business, how smart will I need to be to make money using these products?
Crosland: Most traders are smart individuals. We do try to make things as easy as possible for the trader but there does have to be a willingness to understand currencies and what affect certain news announcements and political conditions have in influencing their price.
Many traders who become interested in the forex market start with a demo account. Once they are comfortable trading 'Monopoly money', they open a mini account (our minimum deposit level is $250) and trade the micro lots. Doing this in combination with the educational resources on our website means the customer can actually enter the market with very limited risk.
Hougaard: It's 99% knowledge about the market and 1% about how to click the buy or sell button. People do get a little bit flustered the first time they sit in front of the trading platform with a whole lot of bells and whistles and flashing figures. It might be a completely new experience if you have always dealt with a stockbroker servicing you over the phone but we are there to make that transition as smooth as possible and help you as much as we can.
Make sure your strategy and discipline are correct and your stop loss is in the right place and worry less about whether there's spread or a commission because if you can get the direction right, these considerations are secondary.
Miller: We have designed these platforms to be very simple to use, so the smart thing is how to use the product and the underlying instrument, not how you click on the buttons. With CFDs, compared with ordinary share trading, there are a lot more steps to placing a trade. We differentiate between the ordinary person in a bank,who wants to maybe sell some shares online, and a CFD client who is a bit more sophisticated.
Lacey: Being computer savvy seems reasonably important. Perhaps if you've got experience of buying online, it's less of a problem than it must be for someone who has always used a telephone.
Scott: Yes, but all companies have people on the other end of the telephone who will be experts on the product and will normally be happy to field questions and guide you through getting started. There are seminars and educational events, help pages, demo accounts - all things designed to help overcome the psychological barrier that online platforms may present. In terms of how smart you have to be, get some goals in mind, get risk management in mind. Boil it down to some simple rules and then be disciplined and stick to them. You can be smart by keeping it simple.
Miller: I'm assuming people reading this are interested in shares and already aware that they need to do a lot of research to pick good stocks to trade. I think it's reasonable to assume that if you are comfortable with trading physical shares, you are already smart enough to trade CFDs.
Moczulski: We all have account managers, so don't feel scared of calling up. One of the ways to help you decide which provider to use is to give the firm a call. How quickly do they answer the phone? If you do trade on the internet, there are always circumstances where it goes down, so make sure that there are dealers there to help you out and to hold your hand on trades.
Lacey: Most of you have got online resources such as charting as well. It wasn't so long ago that this was exceptional.
Miller: We all provide more than clients actually need but you pick and choose what you do need and do your research.
Lacey: Another point about choosing providers involves the difference between whether they classify you as a private or an intermediate client for FSA regulatory purposes. How does that work?
Miller: This is really important. If you move from share trading into CFDs or spread betting, one of the clear divides is between the brokers that classify you as a private client and those that classify you as an intermediate. If you choose the wrong broker, you can lose a lot of the protections you've been used to with ordinary share dealing, so I would say always choose one of the big names in the industry, someone who's been there a long time.
Moczulsk: We are regulated like any other stockbroker or futures broker and whether you are classified as intermediate or private, you still have that protection. The things that you lose out on as an intermediate are the right to best execution and services such as the private investor compensation scheme. To confirm, spreadbetting gives you these as you are classified as private, CFDs generally don't as you are intermediate.
Lacey: Can we sum up very briefly the differences between the private and intermediate client?
Moczulski: To be classified as intermediate, a client has to have experience, whether that's three to four trades a month for 12 months of physical shares or three to four margin trades for six months. Only intermediates can trade in some contracts.
Scott: We are intermediate on some products, private on others. If you want to trade futures, FX, or over-the-counter CFDs, you would need to qualify as intermediate.
