Investors tempted by the improved accessibility to CFDs should take precautions against the risk of leveraged investments, a leading market educator has warned.

Julie Cairns, managing director of Sydney-based Trading Pursuits, says the ASX’s recent decision to reduce the number of options in CFDs (Contracts For Difference) from one thousand to one hundred, had opened up the product to smaller investors and SMSF trustees.

While Cairns says the ASX’s initiative makes for a more liquid and robust market, she warns that CFDs represent more leverage than most investors are accustomed to and anyone trading them should have a strategy.

“If you use a stock broker’s margin-trading facility, you have a two-for-one leverage,” says Cairns. “But when you trade CFDs, your leverage is ten-for-one. That is, for every dollar you put up, you have ten dollars’ exposure in the market.

“Leverage can help you make more gains, but it can speed your losses too. The costs of ignorance are huge when you trade on leverage – you must have a strategy before you start.”

Cairns says the reduction in the number of options used in an ASX-traded CFD was one reason that the market was seeing more interest in leveraged trading, but she says the generally poor performance of superannuation funds has also made accelerated gains seem more attractive to non-professional investors.

While all stock market trading should adhere to some kind of strategy, Cairns says it is most crucial when using products such as CFDs. People who use CFDs in their trading should have a plan that includes:

• assessment of risk factors
• protection from downside risk
• profit-taking strategies
• diversification.

“Anyone who buys stocks should start by evaluating how much they are prepared to lose,” says Cairns. “This is most important for CFD strategies. They are highly-leveraged so you must know your own risk profile.

“Secondly, there are strategies that even first-timers can be taught in terms of how to mitigate some of the downside risk. They include using stop-losses, hedging with put options and rolling down your break-even point by writing covered calls.”

Cairns says investors who use CFDs and other leveraged approaches must know all the risks, including credit risk, currency risk and counter-party risk.

“Thirdly, do you know how to take profits from your trades? Many people are not aware that professional investors sell-down a stock as it goes up. You should have a strategy for this so you ensure you take the profits when they are there. Profits on paper are not profits in your pocket.

“This goes equally for your stop-loss position – the point at which you will accept no more losses.”

Cairns says investors using CFDs should also be very clear as to what is a diversification plan.

“Diversification is not simply buying all of the bank stocks. Diversification means you hedge your bank stock play with a stock in another industry.”

She says SMSF trustees have a legal obligation to understand what they are doing, and to educate themselves before they make a trade.

“Leveraged trading can accelerate your gains, but it can get you into trouble very quickly,” says Cairns. “When using leverage you must educate yourself, formulate a strategy and then have the discipline to trade according to that strategy.”