Bernard Hickey speaks to IG Markets Institutional Dealer Chris Weston in this Double Shot interview on Contracts For Difference (CFDs) and how investors and traders are using them in Australia and New Zealand.
IG Markets has expanded into New Zealand over the last six months from its Australian base in Melbourne, offering clients NZ dollar accounts. Based in the UK and listed on the London Stock Exchange as IG Group (IGG), IG Markets has seen its New Zealand clients mostly trade in currencies.
"About 90% of our clients over here have been currency traders," Weston says. Clients prefer to trade the Euro-US dollar, the UK pound-US dollar (cable) and Australian dollar-US dollar pairs, rather than in the New Zealand dollar-US dollar pair, he says.
Customers can use CFDs either to hedge underlying positions in currency or stock markets or as a way to speculate in a geared way, he says.
"We've seen a big pickup in people looking to hedge their physical exposures rather than selling out of their underlying portfolio, which can be costly and take a bit of time," he says.
"That's been quite a useful tactic in this volatile time."
Weston says news events tend to drive trading patterns, particularly around gold and currencies.
Risks and regulation
Asked about the risks with brokers, given recent broker collapses in Australia, Weston says IG Markets offers segregated accounts.
Clients needed to ask a series of questions when looking at potential brokers, he says.
"Have I got a segregated account and what physically can a broker do with it? Can they use that client money to pay off margin positions. At IG we don't do that. We use our own funds. We've got a big surplus cash position and no net debt. We use our own money to pay off brokers," he says.
Asked about moves in Australia to toughen regulation for CFD traders, Weston says IG Markets is working closely with the Australian Securities and Investment Commission (ASIC) to educate traders about the risks involved.
IG Markets rejects 10-15% of clients because of a lack of understanding of its products, Weston says.
IG Markets is sponsoring the news section of interest.co.nz and offers a range of seminars for investors. There's more information on seminars here on the IG Markets website.
Here's more information below from IG Markets on trading currencies using CFDs. There's more information here on the IG Markets website also.
Forex and FX
The foreign exchange market (also referred to as FX, currency trading or the forex market) is a worldwide decentralised over-the-counter (OTC) financial market for the trading of currencies. Financial centres around the world facilitate the trading between buyers and sellers across the globe.
There is no difference who you trade FX with, whether it be a bank, CFD provider or a specialist FX provider as the prices quoted are all OTC and will be very similar between all institutions.
The only difference is the dealing spread. The FX market has evolved into one of the largest and most liquid financial markets in the world.
It’s popular because it allows you to trade on margin, is available 24 hours a day (except weekends) and has low trading costs associated with it. Trading FX on margin FX is normally traded on margin. For a relatively small deposit, you can control a much larger position in the market. When trading popular currency pairs like the AUD/USD and EUR/USD, most FX and CFD brokers offer trading on a margin basis.
Some brokers offer as much as 1% margin on positions, meaning you only need to put up $1 to control a $100 position. However, this magnified exposure also means that FX trading can result in losses that exceed your initial deposit. Risk management Trading in geared markets like FX comes with significant opportunities and risks, so it is imperative that you learn how to manage your risk and portfolio effectively.
Fortunately, most FX and CFD providers offer a wide range of risk management tools that wont cap your potential for profit. These tools include Trailing Stop orders, Guaranteed Stop orders and Limit orders.
FX pairs
FX trading is done in pairs making it important to keep abreast of more than one country and market. For example, if you trade the AUD/USD, the Australian dollar is based on the U.S. dollar. So an AUD/USD exchange rate of 0.85090 means that one Australian dollar is the equivalent of 0.85 U.S. dollars. If the AUD/USD exchange rate rises to 0.86090, it means more U.S. currency is required to buy one Australian dollar.
Major currency pairs include AUD/USD, EUR/USD, EUR/GBP, USD/JPY, GBP/USD, and USD/CHF.
How FX trading works
For all FX trades, you simply 'buy' if you think the first denomination in the FX pair is going to rise, and you 'sell' if you think the first denomination is going to fall. If you are looking to take a short-term view, you can trade on the Spot price. If you want to take a longer-term view, you can choose a Forward contract.
The spread
When trading FX, you are quoted a spread, offering a buy and sell price. Most major FX and CFD brokers offer a variable spread which reflects the underlying market and can sometimes be from just 1 pip. This means you can sell the Australian dollar against the US dollar at 0.85080 and buy at 0.85090.
There are no further costs or commissions.
There more information about the risks and details involved in FX trading using CFDs here.
32 Comments
Justice,
One man/woman's speculator is another man/woman's market maker.
One thing New Zealand can be grateful for is an extremely liquid forex market.
We wouldn't have that without speculators.
A liquid market is valuable. Just look at our stock market...
cheers
Bernard
Businesses who produce products need capital. Capital is raised from the public by share offerings. No one wants to be involved in shares if their investments are illiquid or don't have the prospect of reflecting true value via liquid markets. Ergo, liquid markets help productive companies raise capital to produce products, leading to employment.
Foreign exchange traders maintain liquidity in forex markets, giving the same level of certainty over foreign positions for importers and exporters.
Having said that, I'm not a fan of CFD products. I think that most people who trade CFD's (well, amatuer traders anyway) may not necessarily understand the product that they are dealing in.
This guy talks about their "product", but wouldn't that mean they should actually 'produce' something 'productive'?
Example:
Like when a Market Gardener produces Broccolli say, he plants it, watches it grow while caring for it's environment and then when it's mature he sells his produce to the highest bidder.
He does SIT ON HIS ASS at the growers market and make bets on what the price will be when the broccolli is brought or sold!
CFD's and other derivitave contracts can help that broccolli grower be more productive though. Lets say he needs to sell it overseas but the price of particular currency in question is all over the place making it hard for him to budget for his following season. He can hedge his currency risk out of the equation (along with other variables), often times at a good price since the timing of it comes down to when he want to as opposed to when he has to sell his crop, hence making him more profit and thus giving him the ability to more productivly deploy capital to other parts of his buisness instead of having to hold cash reserves to make up potential short falls. The CFD or derivitive in itself isn't productive since it's a zero sum trade (someone always wins and someone always loses), but it helps the producer be more certain when budgeting. And if you think about massive companies say for instance Nestle they could have massive swings in profitiblity since they have input cost that can vary seasonally sugar, cocoa etc. Hence hedging for them is essential. If there were no speculators in these markets, increasing liquidity, hedging especally on a large scale would cease to be effective as the price would be all over the place. So speculators do actually provide a service to producers making them more efficent in capital allocation and thus increasing their productivity.
Thats a fair question BM.
To answer your direct question
"If there was not as much speculation, maybe there would be less need to hedge?"
My answer would be there still would be a need because unless you had some sort of global system were exchange rates were completely static, there would still be risk of fluctuations and therefore a need to hedge especally if you say had a huge turnover but very low margins.
But your statement/question I guess is, would less speculators mean less volatility?
Thats debatable. If there was less speculator there would be less liquidity and big trades/exchanges either way would cause bigger swings. And if you had less liquidity would risk be accuratly priced? I would think that there would be much more seasonal volatility as demand for our exports increased. But really it would be almost impossible to stop buying and selling of just one small currency in one part of what really has become a interdependant global economy.
One thing I would say about other futures markets (commodities, metals etc), is that when there are less people trading around holiday times in the Northern Hemishpere it is way more volitile especially when there is a bit of uncertainty around. So for those markets at least more speculators actually make the price less volatile.
They could do that but you then have a whole new set of problems. If you were talking about USD pegging here is a copy and paste of potential problems. Sure there are benifits but do they outweight the disadvantages. Sorry for the lazy answer :)
Disadvantages of Dollarization
There are some substantial drawbacks to adopting a foreign currency. When a country gives up the option to print its own money, it loses its ability to directly influence its economy, including its right to administer monetary policy and any form of exchange rate regime.
The central bank loses its ability to collect 'seigniorage', the profit gained from issuing coinage (the minting of monies costs less than the actual value of the coinage). Instead, the U.S. Federal Reserve collects the seigniorage, and the local government and gross domestic product (GDP) as a whole thus suffer a loss of income.
In a fully dollarized economy, the central bank also loses its role as the lender of last resort for its banking system. While it may still be able to provide short-term emergency funds from held reserves to banks in distress, it would not necessarily be able to provide enough funds to cover the withdrawals in the case of a run on deposits.
Another disadvantage for a country that opts for full dollarization is that its securities must be bought back in USD. If the country does not have a sufficient amount of reserves, it will either have to borrow the money by running a current account deficit or find a means to accumulate a current account surplus.
Finally, because a local currency is a symbol of a sovereign state, the use of foreign currency instead of the local one may damage a nation's sense of pride.
Mark - you seem like the kind of person that might be able to help with questions in my comments 8.41am and 9.49am today. I'd be grateful for any insights please.
In some ways this is a bit like the discussions we see around property investment, Bernard, where we seem to be addressing a question, at what point does sufficient property investment become too much property investment?
The same here perhaps, when does enough liquidity become too much liquidity, when considering the downsides?
Cheers, Les.
Hi Les
841am
Q1 Derivatives trading has been around for a very long time
http://husky1.stmarys.ca/~gye/derivativeshistory.pdf
Q2 Its a zero sum trade, someone wins and someone loses the corrosponding amount. The reason for the high leverage is to take control of a large amount of a "thing" without the innefficency of allocation huge amounts of capital to it.
Q3 I beleive it's more to do with the advent of high speed communications and computing power as opposed to the derivitive itself that has increased volatility. If you read books on the subject back in the 80's even early 90's you can tell it's a different ballpark now. I don't know how you would go about putting the technology genie back in the bottle. Easy to say much harder to do.
Q4
Check out this website it has most of the volume numbers there.
http://www.cftc.gov/OCE/WEB/index.htm
949am Q1(above) and I would say that internal consuption would have been much higher back then. So was there a lack of liquidity back then? Probably not for the amount of global trade back then as there is today. Would it have been slower and less efficent. I would say yes.
"The same here perhaps, when does enough liquidity become too much liquidity, when considering the downsides?"
I dont have an answer to that one.
Thanks Mark. I'll mull over those answers, useful. You didn't respond to these two though, that I had asked of 'Jack' in the 8.41 comment:
a) I wonder if wider spreads might be a price worth paying when speculative volume based volatility creates movements many multiples of the spreads you state, in timescales relevant to real goods and services trading and in particular when considering that many import/export transactions are smaller than the sums you suggest and comensurate with the size of typical NZ businesses performing them? (There are few with $100mio t/o, nevermind making similar size conversions regularly.)
b) Would it not also be the case, that our fx earners would all benefit from reduced bid on NZD (see article - am referring to the Bloomberg article in earler comment Mark) if it were less traded, meaning a few extra points in spreads at conversion time is outweighed by extra profit?"
As for not having an answer to:
"The same here perhaps, when does enough liquidity become too much liquidity, when considering the downsides?"
Some countries do - capital controls*, particularly involving residence times, as I guess that seems the most logical way of dealing with the speed driven amplication effects resulting for higher tech. communications. [* these work, Tobin/transaction taxes are academic IMO.]
Here's another one for you, do you think we could get to the point where enough liquidity is not too much liquidity, by reducing our interest rate and thus interest rate differentials with other (carry) currencies? [By say controlling inflation by money volume based tools and macroprudential approaches.] Might this mean we would see some useful, equitible answers to questions a) and b), above?
Cheers, Les.
Les glad you found those interesting
I think the prudent approach would be to initally reduce the need for interest rate rises with capital requirements policies etc. I think we have discussed this before or you have written about it. If that isn't done the carry might be too attractive (the bloomberg article link was interesting and just goes to show that this could really be a problem if we go to 5%ocr and the US is still at similar rates to now) and overide any spread increase and/or attempt to drop trading volume.
That being said imposing a capital control mechanisim seems like a drastic step to take at the moment ( maybe required later though) and maybe should be left as the final bullet in the gun.
Sorry if I havent answered or missed some points its been a long day.
Thanks again Mark. Re. the prudential approach, I don't recall discussing with you, but I have waxed on with supportive views. (Am pleased IMF have been publishing so supportively on same too.)
It's interesting to read your response to the idea/approach given your work as a derivatives trader. See, you guys are not as evil as some people make out! You actually know what drives the dynamics, I wish others could get a similar grip on things .... anyway ...
I hope you've got the replies to comment thingy switched on as I'd like to carry on this discussion a little further when I get time in next couple of days, maybe later today.
Cheers, Les.
Justice says - "All he does is SIT ON HIS ASS at the growers market and make bets on what the price will be when the broccolli is brought or sold!"
I agree and unfortunately he makes 10 times more money than the broccolli grower. So much for the productive sector. I hope that Jim Rogers is correct when he says that farming will be the most lucrative industry in the future.
A lot of people in many countries invested in property which is non productive and caused a lot of misery for population . This sounds true to me, however the alternatives such as buying gold/copper or other commodities or currency trading/CFS etc are non productive activities as well. How would it help society if people who have money start to pile and control the price of commodities in order to make money, such people are not better than PI . Saying this should not lump me with property bulls, my point is that not all activities related to Stock/currency markets are productive except for individual gains .
CFD trading allows you easy access to a wide range of instruments in global markets with minor spreads. Currency, Commodities, Stocks, Indexes.... it's all good. The NZ market is very small and this tool allows you to get out into international market easily... But with some degree of risk if you don't know what you are doing from leveraging...
I'm a fan, but many may not be as it's not a buy and hold strategy...
It is important to notice that statisticaly 95% of all trades go wrong and it takes skill and little luck to be on the right side of the trade. But a proper money management strategy will keep you safe in such a high leverage environment. It is leverage what makes FX trading so risky
Dont forget there are two parties to each trade, one winner and one loser.
I have to disagree with this. Trading is not necessarily a zero sum game - different risk profile, portfolio allocations and many other factors explain why people engage in a particular trade - there is not necessarily a loser on the other side of your winning trade.
Bernard - you just don't get it, do you.
All, repeat all, repeat all, economic activity, sooner or later, has to be underwritten by real stuff done with real stuff.
If virtual economics worked, there would be no problem and I'd be game-playing as we speak. Virtual economics gives virtual wealth. Nothing.
So this activity has to, in the end, soak a share of the broccoli man's effort. It's all in an old kids' book called 'Not I, said the Little Red Hen'.
The real stumbling-block is that all advanced capital - from whatever source - needs to be underwritten, and more importantly the interest/usury charged has to be underwritten, by future activity.
Activity is work, and work requires energy.
If there is not going to be the same supply in the future, there isn't going to be the same work done, and therefore a reduced underwriting potential. This approach is just a parasite in the gut of a dying host.
Irrespective of which gamblers win at the expense of which other gamblers, it's become a zero-sum game at best (but has already been overshot) and wil trend to a reducing one.
Wayne Lochore has just written a piece (contrarian on demographics) which explains it very well - maybe you should purloin it for the top 10.
Wayne,
What happens though when you want to sell some New Zealand dollars to go on an overseas holiday or you want to buy some imported products.
How will you be sure there is a liquid market with a reasonable price? That's where the speculators and hedgers and traders come in...
cheers
Bernard
Bernard - was this much of a problem in the days before speculative, hedging, trading activity became as intense as it is now? Was there insufficient liquidty back in those days?
Am also interested to get any help with my questions above please. Plus do you have anything on volume growth of such activity over say the last 10 to 20 yrs?
Cheers, Les.
Hi Wayne
But surely everyones intent is to make a profit. If both sides can do it whats wrong with that? To me it's like having insurance on you house. You could self insure but you would need to have a whole heap of cash standing by to do so. Does that make the insurer of no economic value to you or to the ecomony at large? Of course not it means you invest money you wouldn't otherwise be able to safe in the knowledge your covered. Is the insurer there to make a profit? Yes. Does he provide a service to the economy that is benifical? IMO yes. Is it advantagous to both parties? Yes.
One other thing I didn't point out in other remarks that people may have missed is that derivitaves have no directional bias. Unlike shares that have an upward bias since a companies main goal is to make a profit (and yes I realise you can short shares), derivitives go up and down since gold or wheat or whatever doesn't have a goal to make money. It just is what it is. So when people say speculators buy up gold to copper or whatever to make a profit, they could just as easily be shorting it driving down the price to make a profit.
It is just nuts to NOT have a small Tobin tax on all the massive currency transactions around the world that are going on all the time.
I still say that there is less wrong with "hedging" type financial instruments, than there is with property price bubbles themselves. It is the money wiped out in the latter that does the real damage to the real economy. A whole lot of hedge transactions between wide boys, is just peripheral and need not concern Joe average. But get a property bubble started, and Joe average is going to be affected whether he likes it or not.
The property bubbles were NOT STARTED ANYWHERE, BY financial instruments. The financial instruments were drawn to the bubbles like "gravity", AFTER they got started. The responsibility for not stemming the rising tide of land prices, lies solely with the urban planning bureaucracies. Nations all over the OECD that did not have CDO's and CDS's and Fannie Mae and Alan Greenspan's 1% interest rates; STILL have had bubbles just as bad as the various "USA" States ones - including NZ and Aussie.
I have come to believe that the main thing that has made the "down" volatility of the USA States bubbles so much worse than anyone else's, is their brilliant "liberal" law about equity losses in a property having to be sustained by the lending institution, not the mortgagor. Of course people will just walk away from their house when the mortgage goes "underwater". A recent OECD report on housing bubbles said that regulators and lawmakers should be careful that anything they did was not "pro cyclical". The USA's laws about mortgagor immunity, are like a turbocharger bolted to the "down" phase of the property cycle. If we had laws like that, our house prices would have halved from their 2007 peak by now.
It is just sickening to see the repeated comments all over the place about "the failures of the free market" and "deregulation", yadda, yadda, yadda.
PB - sorry, you still have to come to grips with the finite nature of the local terrain.
Could I suggest a small experiment? Start walking in any given direction. Keep going. Hope you have a lifejacket.
then there's exponential growth, and the inevitability it fiscally overrun the ability to physically underwrite.
I've just posted an oldie of mine, re just that, on my powerdownkiwi.wordpress.com blog.
Hope you like cheese..... enjoy
Mark - I think a key question that you didn't address and that we as a nation need to address, regarding the supposed benefits of lots an' lotsa extra liquidity, (slightly cheaper holiday cash and cheaper imports, as advocated by Bernard above) is, can we stand a few extra* pips in the short-wavelength dynamic of b/a spreads if it means we lose the damaging longer wavelength dynamics the order of cents and percents brought about by - more than we really need liquidity - where NZD get's traded more than 40% of gdp per day! - so that better conditions prevail for the real economy to thrive? (*a few pips, or cents and percents?)
See the recent New Zealand Institute report, 'A goal is not a strategy: Focusing efforts to improve New Zealand's prosperity', from page 44:
"Exchange rate policy
The floating exchange rate is a mixed blessing. If New Zealand was only goingt o be a dairy product exporter the floating exchange rate would be beneficial because it provides a natural hedge, smoothing out the effects of dairy price changes. When commodity exports are strong the exchange rate appreciates and the outcome is as it should be – the high value of the New Zealand dollaris earned by the fundamentals of our export position. When commodity exports are weak the dollar depreciates so the country earns more New Zealand dollars for each unit of volume exported. Earnings in New Zealand dollars are smoothed.
The outcome for exporters of differentiated products and services is not so good. Exports are usually priced in the currency of the destination market so the consequence of the exchange rate rising and falling for non-commodity exporters is that earnings fluctuate. A government inquiry into the future monetary policy framework in New Zealand found the exchange rate had been “volatile and subject to prolonged periods of under and overvaluation, potentially constraining growth in both the value and the volume of New Zealand’s exports” (Finance and Expenditure Committee, 2008, p.14). Volatility of earnings is very harmful for small growing firms and causes financial distress that makes it even more difficult for them to succeed. Uncertainty creates risk that discourages investment, so policies to reduce exchange rate volatility or its impacts are needed to grow differentiated exports successfully."
As for appropriate capital controls, other developing countries use them - have you seen where we now sit in OECD rankings?
Read the NZI report and similar on the NZMEA and PEC websites and ask, should we not be thinking more like a developing country, and so implement a monetary policy that helps arrest our slide down the prosperity rankings and allows us to maintain, or maybe even, again start developing toward a place in the first world?
Cheers, Les.
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