Making Money From CFD Trading

How I Turned $13K Into $30K in 3 Months

Catherine Davey

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9781740311502
• eBook ISBN: 9781118303917
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Finanzwesen

Contracts for difference or 'CFDs' have taken Australian traders by storm. Catherine Davey's first book on the subject, Contracts for Difference: Master the Trading Revolution, was a great success; in this follow-up, she shares her real-life CFD trading experiences over a three-month period in 2005. During this time, she manages to turn $13000 into $30000, but her path to success is anything but straight and simple.

Making Money from CFD Trading describes not only the reasoning behind and execution of her trading strategies, but also presents an honest, inspiring and often humorous discussion of her emotional journey as a trader. Catherine gives a fascinating insight into the trading experience: struggling to maintain the right psychology, avoiding irrational 'ego trades' and finding emotional balance between depressing losses and big wins. She presents a range of opinions from industry experts and commentators, discussing day-to-day trading issues and sharing controversial market views. This book will give you an understanding of:

• simple charting techniques that make money
• the unique aspects of trading CFDs
• how to exploit the advantages CFD trading has over traditional share trading
• strategies for establishing and maintaining a winning mental approach.

This entertaining and hugely informative book is a must-read for anyone who wants to know more about CFDs and for traders of any financial instrument who want to take their performance to the next level.

The first cut

Day 1 Tuesday 28 June Total: $12 942

I saw the film Wall Street back in the late 1980s and became interested in trading. Griffin tells me he too first acquired a taste for trading when he watched the film as a teenager, sitting in a shed in Kerry in his native Ireland. I suspect there are many traders who caught the trading bug that way, in the days when the most famous line from the trading world was, ‘Greed, for want of a better word, is good’. The greed is good quote doesn’t ring true for most traders, though. In fact I think the majority would say greed is often their downfall. I have two other favourite quotes from the film. The first is another Gekko saying, ‘Greed captures the essence of the evolutionary spirit.’ I think greed, the compulsion to make money, motivates us to trade but then leads us to areas of ourselves that we wouldn’t normally go to. I think this is the reason why so many traders fail and give up. Lessons you learn about making or losing money can be painful, but the personal lessons you learn sometimes hurt even more. My other favourite quote sums up this phenomenon: the good guy character Lou says, ‘Man looks in the abyss — there’s nothing staring back at him. At that moment, man finds his character, and that’s what keeps him out of the abyss.’ There are very few events in an average person’s life that will take them to the abyss, but if you trade, I can guarantee this will happen, and if you persevere, you’ll find your character.

It all sounds melodramatic, but until you actually start trading you can’t understand the enormity of the emotional journey involved. Someone once told me the best traders do it for the selfdiscovery, not the money. I suppose it’s something like that old saying, ‘What matters is the journey, not the destination.’

Before I even start my journey, I have to answer an important question: how much should I deposit into my trading account? I ask Griffin. ‘In general terms, if you want a 20 to 30 per cent return on your money, an account balance of $30 000 to $40 000 would be good,’ he suggests. I had thought that average clients started with about $10 000 in their accounts. ‘Yeah, about that,’ Griffin says, ‘maybe a little higher, say $20 000.’ I set up a new trading account with a fresh balance of $13 000. If you consider that every $1000 is really worth $20 000 or $30 000 because of leverage it seems like a reasonable figure, and I should be able to make some money from it. I like the number 13.

My first trading day is a Tuesday. I start the morning by checking the local index (the S&P/ASX 200) and the Dow. The local index has not been tracking the recent huge losses on the Dow, which was down 166 points last Wednesday and a further 120 points on Thursday. I take this as a positive. When any market bucks a general trend or a major market or sector trend, it shows its own underlying strength. A large move down in the Dow that is not followed by an equivalent downward move in the local market means that local stocks have more ready buyers, at least in the short term.

It’s not just the relationship between the US stock market and the local stock market that works this way. If a particular stock doesn’t move down with its market sector, this often indicates relative strength. For example, if there were a move down in, say, the Australian materials sector index (XMJ), but Bluescope Steel (BSL) stock managed to beat off general index bearishness and make a strong move higher, many market participants would interpret this as a demonstration of BSL’s underlying bullishness. This is not always the case, though; sometimes it’s a matter of a particular market or stock playing catch-up.

I enter long positions in two share CFDs, both based on a simple break of resistance, one on Aristocrat Leisure (ALL), which can behave like a bucking bull, and one on Bluescope Steel (BSL), one of my favourites. I jump straight into both of these positions. I don’t have trouble pulling the trigger, but many new traders do. This is normal, and there are a number of things you can do to build confidence. The first is to make sure you aren’t gambling. Without a commitment to a trading strategy or approach, your trades are random and therefore tend towards gambling. When you don’t have a system you believe in or are put on a trade without confidence, you will find pulling the trigger difficult. Committing to an approach you are comfortable with will make entering trades much easier.

I usually risk around $350 on a single trade. I always try to place my stop-loss order at the same time I place my opening trade, because this is when I’m most objective. It makes sense, because the position size is determined by the stop-loss level.

The general rule around the markets is not to risk more than 2 per cent of your total capital per trade. Personally, I generally choose to risk a maximum of $350 per trade. This represents 2.7 per cent of my trading account starting balance of $13 000. If my account balance drops below $13 000, I do not automatically reduce my risk amount. I might have ten trades open at once, risking $350 on each trade. The amount of dollars you have decided to risk per trade will determine the amount you can invest, and therefore the size of the position you can take.

For example, imagine that I want to trade ALL, and that I open a position when ALL is trading at $11.17. I decide that I should exit the position if the price falls below an old chart support level at $10.85, so this is where I place my stop-loss order. The difference between the entry point and the stop-loss point is 32¢. I divide $350 by 32 to get a total of 1093. This is the number of share CFDs I will trade. I round it down to 1000 for the sake of convenience. This approach ensures that I am always trading a position size that takes into account my stop-loss level, my account size and my maximum risk amount.

To summarise, the way I determine my position size is to:

1. identify the entry price

2. identify the appropriate stop-loss level

3. determine the difference between the entry price and my stop-loss level in cents

4. divide my ideal risk amount by this figure.

This tells me the number of share CFDs I should trade — that is, my ideal position size.

Some stocks are more volatile than others, so they need wider stops. If you place a stop too close to your entry level, you don’t give the price enough room to move, and you’ll find that you are stopped out before you’ve had a chance to make any gains. However, when you set a wide stop, you should reduce your position size accordingly, to limit the amount you can lose.

When I’m making a decision about how tight a stop should be, I look at a stock’s liquidity and what I call charting predictability. I am comfortable taking a bigger position in BSL than some other stocks, for instance, because it tends to be less volatile and more liquid, and it trades more predictably. By this I mean that there are few false break-outs on BSL charts.

Day 2 Wednesday, 29 June Total: $13 145

Before I start the trading day I check the performance of the Dow overnight and recent action of the local index compared with the Dow. I’m looking for anomalies. The Dow and the local index sometimes trade in sympathy, but the Australian market often goes its own way, and this is the case right now. I attribute this current divergence to the recent demand for commodities. Resource-based economies like Australia’s traditionally outperform the stock markets of non–resource heavy economies during a commodity boom. This means the local sharemarket could continue to rally at a faster rate until commodities crash.

The time difference between Australia, Europe and the US means that the local market is open at different hours to the major overseas markets. As a result, many of our larger stocks which are listed on local and overseas exchanges ‘gap open’ rather severely. A ‘gap’ occurs when a stock opens the day at a price beyond the previous day’s extreme; that is, above yesterday’s high for an upward gap, or below yesterday’s low for a downward gap.

BHP Billiton (BHP) and Rio Tinto (RIO) are prime candidates; they often move further up or down on a gap open than they do throughout the rest of the Australian trading day. This can make trading these stocks difficult, and discourages me from trying. Gaps on the open can happen to any stock, but some gaps are so common and so large that they make your best technical analysis–based trading useless — the distance you could normally trade on a short-term basis is swallowed up in opening gaps. Traders with a longer term perspective, who hold positions for weeks or months, would be less discouraged by gaps, as they are less concerned with short-term volatility generally.

A significant move higher on the Dow generally helps our local market rally. The Dow made a triple-digit move higher last night; looking at the local share charts it seems that the Australian market was already anticipating this upward move.

Being a break-out trader means that I prefer to buy as soon as the price of a stock exceeds recent or old highs. I learnt early on in my futures-trading days that a stock is never too high to buy or too low to sell. When a strong bull market is happening, you can forget about ‘buy low and sell high’ — that’s a pipe dream. It’s a case of getting on the bus and not worrying whether you get the front seat or the back seat. The longer you’re in the trading game, the more you’ll understand that the important thing is not your entry, but your management of the open position and ultimately your exit.

For this reason I rarely use a limit order. Instead I enter at market and, unless there is a big gap in price between the break-out level and the current bid or offer, I accept the market price. If there has been a significant jump away from the break-out level I might keep my finger on the trigger and wait until the volume returns to the market before I open a position. Pulling down the price depth window on Marketmaker keeps me posted on the available volume.

Sometimes a stock breaks a key level at or near the open of the trading day and then pulls back. I’ve seen this happen many times with BSL and often wait for it to complete a pullback before I try to buy.

This morning, BSL gaps open and then rallies above its recent high of $8.36, which happened on 20 June. I decide to go long for another 2000 BSL and my order is filled at $8.39. It tops at $8.40 and then starts to fall again. Figuring that a close below the day’s gap open price would be a negative, I cut the whole position at $8.30. I more or less break even on the cumulative position.

If a stock I’m trading does not behave the way I expect it to, it’s usually a sign I should get out of the trade, even if I haven’t made a loss on it — unless of course it runs into a much bigger profit much faster than expected. If I buy on a break-out near the start of the day and then the stock goes back down, a move below the day’s low is usually my sign to exit. This is because a test of the upside has effectively failed and a test of the downside is now on the cards.

Newcrest Mining (NCM) is a stock that often has a very thin order book (limited liquidity), but I’m a sucker for big ranges, and NCM can move more than $1 during the course of a trading day. This stock also trends nicely, which offsets the relative illiquidity. It might typically trade a spread as wide as ten or fifteen cents, especially after a key support level or resistance level has been broken. This stock can really move, so I rarely wait for it to narrow the spread before I jump in.

I see NCM take a fall and then rebound just as fast. With the price of physical gold down US$4 overnight (physical or ‘spot’ gold is always quoted in US dollars), the obvious trade was on the short side, but the obvious is often a trap.

If NCM closes below $16.50, this will be a break of major support and confirmation of a topping pattern. The downside test takes it to $16.58 before it rallies hard. Because NCM is a thin stock, its price can be pushed around and there are always plenty of false break-outs. I get set for a long position at $16.77, a price which represents the first break of resistance since the $16.50 downside was tested and rejected. I watch the stock pull back and then buy some more when it goes above the pullback high of $16.93. My total long position in NCM now is 2000 share CFDs.

I go to lunch and come back to discover the stock’s been all the way up to $17.09 and then fallen back below $17.00 again. It has done exactly the opposite of what I had anticipated earlier in the day, when I decided to open the first long position. It has made a quick move higher and just as quickly retraced those gains. I’ve missed the cue, so I work a stop at $16.89. I base my stop-loss level on a recent resistance level that I expect to turn into a new support level.

It is not until the end of the day that NCM reaches my predetermined stop level. I take the whole position out at the close. This is not always the best time to trade, because prices can be very volatile in the last few minutes. Griffin says that, on average, 30 per cent of the day’s business is executed in the last ten minutes of trade. I ask him about other Aussie share CFDs that can be extra volatile into the close, and he mentions Arc Energy (ARQ), Brickworks (BKW), CSL Limited (CSL), St George Bank...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Foreword
• Preface
• Introduction
• Getting started
• Week 1: The first cut
• Week 2: Lunch is for wimps
• Week 3: Into the abyss
• Week 4: Wealth god smiles
• Week 5: Avoiding Waterworld
• Week 6: Addicted to trading
• Week 7: My $10 000 week
• Week 8: Subliminal messages
• Week 9: Trading sucks sometimes
• Week 10: Denial and regret
• Week 11: Dogs with nine lives
• Week 12: Golden sheaf
• Week 13: Blonde psycho
• Week 14: Out with a bang
• Postscript
• Hindsight
• Index