Can you stomach a bumpy ride?

The one time I traded contracts for difference, I was highly-strung, nervy and stressed out for the whole week - and it wasn't even my money! I was trading a dummy account, but the whole experience left me scarred and it isn't something I would ever do with money that I'm not prepared to lose.

The one time I traded contracts for difference, I was highly-strung, nervy and stressed out for the whole week - and it wasn't even my money! I was trading a dummy account, but the whole experience left me scarred and it isn't something I would ever do with money that I'm not prepared to lose.

Contracts for difference (CFD) are a complex financial product. Essentially you are betting on the short-term movement of prices in shares and we all know there isn't much science in that. While it might seem like an easy way to make money, you also have to take on board the possibility of losing the same amount of money in seconds. They do, after all, involve leverage, or borrowings, of over 90 per cent of the principal amount. Like all complex financial products, CFDs can be useful if you understand what they are, but don't use them if you don't.

Trading in foreign exchange is similar to CFDs in that you are betting on second-by-second changes in currencies, which are arguably even more difficult to understand than shares.

Foreign exchange trading also involves high leverage - in some cases up to 99.5 per cent of the amount traded is borrowed. Sure it can be a bit of a thrill to watch gains tick over by the second, but I, for one, am not prepared to pay the price of the reverse happening when I look away from the screen for a minute.

Hybrids, which are a combination of fixed income and equity, are another product you need to understand fully before using. These products have been quite popular lately, as many offer an income that is much higher than the cash rate.

But did you know, for example, that the issuer may have the option of suspending interest payments for a number of years? Or that you would have to line up after senior bondholders and other creditors to get your capital back if the issuing company went bust?

Hybrids are a key area of concern for the Australian Securities and Investments Commission (ASIC). It is worried that they are being sold without a proper explanation of what they are. It has also pointed out that interest from institutional investors - the professional guys in charge of billions - has been poor, which is often a good indication that the issuers might be trying to take advantage of retail investors' lack of understanding.

These products are all legitimate financial instruments, and very useful for some kinds of investors, but the problems revolve around to whom and how they are sold. If the GFC has taught us anything, let's hope it's given us realistic return expectations. If you want returns in excess of double digits, then you've got to take on board the risks that come with it.

One final piece of advice - never be afraid of the "stupid" question. There are none. If someone makes you feel silly for asking one, hang up the phone, leave the room, or delete the email.

Penny Pryor writes a regular column for Sunday Money, in The Sunday Age.

David Potts returns next week.

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