Instrument Understanding

Instrument Understanding

Not Understanding the Instrument Being Traded

Being over-the-counter products, there are a great many differences in the specifications of contracts available as CFDs. If you are trading these products, it is your responsibility to know what these specifications are.

For example, what exactly does 1-CFD of this underlying security represent? Is there a physical underlying security? Is there an expiry?
What if you still hold an open position at expiry? Is there a financing fee? Can it be sold short? What are the trading hours? Which currency is it priced in?

Speaking of currency, have you considered the impact that movements in the AUS could have on your holdings? Do you have a currency overlay strategy in place to dilute the impact of adverse currency movements? If the AUS gains against the currency of the country that you have invested in, any gains you might achieve in that foreign position will be eroded.

Even worse than that, if you have incurred a loss on your foreign  position, a weakening AUS will amplify this loss.

By far, the majority of traders invest in CFDs where the underlying equities are listed in their own country. This is known as ‘home country bias’. The simple reason for the existence of this phenomenon is that traders are more comfortable trading CFDs on underlying securities that they are familiar with. How well do you really know the market conditions in the USA or Asia? How well do you know the local conditions and regulations of those foreign markets? Is it really convenient or practical for you to sit up for half the night to trade a CFD where the underlying security trades on an exchange on the other side of the world?

Sometimes, it might be better to stick to CFDs based on markets that you are familiar with rather than venturing off into markets you don’t fully understand.

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