Trading and investing are two very different approaches. In a previous article, we wrote about the reasons why some would people prefer trading to investing.
IG Singapore recently introduced a new product called the Singapore Index CFD. This product allows traders to gain exposure to the Straits Times Index (STI) via an Index Contract for Difference (CFD). This could be of particular interest for local traders who are looking to have trading exposure to this popular index.
Before trading the Singapore Index CFD, we think it is important to first understand the product.
#1 You Are Trading, Not Investing
Put simply, investors tend to adopt a longer holding period with the aim of realizing returns when the assets they invest in increase in price over the long-term or pay out dividends with minimal turnover. In contrast, traders tend to adopt a shorter holding period with the aim of making profits through short-term changes in price. Typically, traders use technical analysis, studying patterns in charts and historical price movements, to help them identify entry and exit positions.
If you are intending to gain exposure in the STI via a CFD on the Singapore Index, a trading mind-set is commonly adopted. Due to the nature of a CFD, with leverage and overnight funding costs, this product appeals to those looking for shorter holding periods or alternatively those intending to use the Index CFD for hedging their cash position in the component shares.
# 2 You Are Trading The Index Through A CFD
Trading a CFD is very different from investing in an ETF that track the performance of the STI.
A CFD is a contract between two parties to exchange the difference between the price of an asset from its opening position to its closing position. Its value is dependent on the underlying asset that it is tracking, which in this case, is the STI.
Due to the structure of how CFDs work, traders can take either long or short positions in a trade. They take a long position if they think prices will go up and a short position if they think prices will go down.
# 3 You Are Employing Leverage
If you are trading the Singapore Index using CFDs, you will be utilising leverage, or trading on margin. Hence, you need to be extra careful in your trades.
When you trade using leverage, a small change in the index can have a significant impact on the value of your trade, for better or worse. For example, with a leverage of up to 20 times, if you are long on the index (i.e. you think the index will go up) and it does go up by 2%, your profits will be as much as 40% because of leverage. However, if the index goes down, your losses will likewise be magnified. In other words, leverage is a double-edged sword that can help traders increase their exposure and magnify both their profits and losses.
Simple ways to manage your risk include setting a stop-loss position or a trailing stop which automatically adjusts your stops levels as your position becomes more profitable, so that you are able to lock in potential profits at it comes in, while at the same time keeping your downside limited. Unless you are very experienced, you should also avoid trading during times when a significant announcement is anticipated, as you can never be too sure of how the financial markets will react to any unexpected news.
#4 You Can Use It To Hedge Your Long-Term Investments As Well
As an investor, you can also use CFDs to hedge your own long-term positions. For example, if you are invested in the STI for the long term, but expect the next few months to be challenging and volatile, you could limit your potential downside by taking up a short position to hedge yourself in the market. If the STI does indeed go down, your investment portfolio will decrease but that will be offset by the gains you make on your CFD. Full example here.
#5 No Expiry But An Overnight Cost For Funding The Position
Unlike derivatives like options, index CFDs by IG do not have an expiry date. That means similar to investing in stocks, you can hold your position for as long as you want until you decide to close it out.
However, because leverage is being employed (i.e. you are borrowing money to fund the position), you will incur a funding charge for the positions that you hold.
Here’s an example of the charges for an Indices CFD on IG:
At the end of the day, using CFDs for trading or investing should be seen as two separate activities, even if the product that is being used is the same. So before you get exposure to the Singapore Index CFD, determine your holding period and the associated costs to appreciate which approach to use.
You can find out more about IG new indices trading product, Singapore’s Index CFD here.