An Introduction To Online Trading

With the collapse in financial markets more people are choosing to be actively involved in managing their investments to grow their wealth and plan for retirement.

This article provides a very brief introduction to some features you might look for when considering online share trading platforms.

Fees

Fees for online trading vary with some providers offering low entry brokerage fees. There is usually a minimum brokerage that applies and some seemingly cheaper brokers aren’t. Check to see at what level the percentage fee kicks in. Typically this is around 0.1% of a position. So to purchase $20,000 worth of shares, brokerage would be $20 or whatever minimum applies. Be aware that brokerage costs include GST and are for transactions on both sides – that is buy and sell.

Order types

Most online brokers allow for at least two types of orders. These are buy or sell at market, or limit. A limit buy specifies the number of shares that you wish to purchase up to a certain price. These orders can usually be placed when the market is not opened so may suit an end of day trader. An order to buy say 1000 BHP shares at limit $25 means that the upper limit of the purchase price is $25. If the price is higher during trading and then drops to $25 then (depending on available shares from sellers and number of buyers at this price) the order will be actioned. For sellers a limit order tells the broker to sell down to that price.

Readers will note that a limit sell order cannot be used to set a protective sell required to set a stop loss level. You may, for example wish to buy a share at $25 in the expectation of a rise but recognise that at some level it’s time to bail out. I always set a fixed stop order in case the trade goes bad. A fixed or initial stop protects capital, a trailing stop is designed to protect profits. There are a number of ways to determine these levels that take into account volatility, or price movements of the share, technical levels and total trading capital. Stops are becoming increasingly available on equity platforms but may cost more in brokerage. Calculation of these stop levels are beyond the scope of this article but having the capacity to set an automatic stop is useful when you are unavailable to trade or emotion sets in. Holding onto a falling share in hope is rarely a successful strategy.

Mobile Trading

If you’re watching a share and want to know if a certain condition is met but not watch a computer screen a price alert can be sent by text message.

If you want to be more mobile, online brokers and CFD providers now offer phone trading platforms for modern mobile phones such as Apple’s iPhone. Check these out before you rush in. Speed and reliability can be a problem. You will need a platform that is not just a stripped down version of the website but one specifically designed for a mobile.

There are also a range of other mobile phone applications now that provide investor tools such as portfolio watchlists and stock tickers.

Charting

Charting is often quite rudimentary on equity trading platforms. Most traders will require more sophisticated technical analysis packages to determine entry and exit points and back test systems.

Backtesting has become increasingly sophisticated with computers. You can now backtest total systems using rules to identify potential trades and entry, exits and risk management rules with historical data as a guide to how your system might work in realtime. These backtest programs also include sophisticated reports that show a range of performance indicators such as profit and loss, winning trades, drawdown and risk metrics. But beware the disclaimer clause “past performance is not necessarily a reliable indicator of future performance” comes true when you least want or expect it.

Examples of these are Metastock, Amibroker and Ezicharts and the Macintosh ProTA application.

Portfolio management

It is vital that you keep track of trades, for taxation and accounting purposes and also to monitor system performance. Platforms that maintain records of buy and sell, fees and profit and loss records obviate the need to have another program or use of a spreadsheet to keep track of trades.

Derivatives And CFDs

Derivative products (so called because they are derived from share prices) have been around for many years. Examples of derivatives include options, warrants and futures contracts. These arose historically because of the need to hedge prices, say for a farmer planting a crop.

Contracts For Difference (CFDs) are one of the most rapidly growing derivative products. Simply, these are contracts with a CFD provider or market maker that reflect the difference between buy and sell prices of a share or other financial product. In buying a CFD it is important to realise that you are not buying the underlying share, although some of the benefits of ownership – such as payment of dividends - may accrue.

There are a number of stated attractions with CFDs. The first is leverage. CFD providers publish margin rates for shares and other instruments. For blue chip shares such as BHP this may be as low as 5% which means that $1000 can purchase exposure to price movements of $20,000 worth of BHP.

Or how about buying an index such as the ASX200, where the margin is 1%. A $10,000 cash position can provide exposure to $1,000,000.

Leverage is a two edged sword with no handle and money management, important with all trading or investment, becomes critical when trading with leverage. CFD providers give examples of how leverage can work to increase your returns amazingly. But reading the fine print and fully understanding the dangers of using leverage are vital before trading these products. People can and do get burned very badly.

A second stated attraction is (at least until recently when the ban on short selling of shares made life difficult if not impossible) the capacity to short (or sell) CFDs on a number of stocks. If you think a share will go down then sell it and buy it back at a lower price, pocketing the difference. Selling something you don’t actually own takes some getting used to but it can be an effective strategy in market downturns. Contrary to the political hype, many commentators believe the banning of short selling has actually exacerbated the downtrend — at least short sellers have to buy back in at some stage.

I also know of some people who were shorting CFDs to protect the value of their investment portfolio. The ban on shorting meant that this was no longer an option and so some investors are selling their falling stocks, exacerbating the problem.

A third stated attraction is the huge choice of products on the market. It is relatively easy to gain exposure through CFDs to overseas shares, share indices, futures markets and other less intuitive products. Interestingly this includes the United States markets where CFDs are banned as a financial product.

Costs for CFDs include brokerage costs which are usually comparable or less than for share trades, lending costs or interest (since these are purchased on margin) for purchases, and the need to hold a margin account with the provider. Other costs include the pricing spread between buy and sell prices which may vary at different times and for different instruments. If you’re trading a mechanical CFD system these costs can make a considerable difference to return.

Platforms for trading CFDs vary but typically offer an expanded range of order types. For shorter term trading a reliable Internet connection is mandatory.

All of these attractions have downsides. Apart from limited CFD trading through the ASX, most of the time you are dealing with a market maker that sets the rules. Read the product disclosure statement carefully and then read it again. Trading CFDs, or for that matter equities, is not for everyone. There is a learning curve that can be steep and expensive. For every winner there’s a loser and plenty of tears in an unforgiving market. In fact choosing an online broker or trading platform should be one of the last things to consider in deciding to be a more active investor. Investing or trading is not just about picking up a few tips from a magazine. Learning about financial markets can be just as demanding as learning how to manage disease. You will need to learn more about markets and analysis of products, techniques of investing and trading and money management. A good investor is one who, like a good clinician, is disciplined, thorough, keeps good records, is self motivated and even courageous. The use of computers can support these.

Disclaimer

This article reflects a personal journey and the authors personal opinion only. It should not be taken as personal financial advice. Before embarking on any investment you should fully educate yourself as to the risks involved and seek appropriate advice.

Posted in Australian eHealth

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