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BOITUMELO NTSOKO: Today, we’re delving into the world of derivatives. Although the term may seem overwhelming, it serves as an invaluable resource for those who understand it. We’ll break down how derivative trading functions, its objectives, and what beginners need to know to get started. Joining me is Maboko Seabi, a senior analyst at Brokstock. Welcome to the show, Maboko.
MABOKO SEABI: Thanks for having me, Tumi.
BOITUMELO NTSOKO: To start, could you simplify what a derivative is for our listeners?
MABOKO SEABI: A derivative is a financial agreement whose value is based on an underlying asset, which can include stocks, commodities, or currencies.
There are different types of derivatives, the most common being CFDs, options, futures, forwards, and swaps. However, CFDs, or contracts for difference, are the most widely used by most traders.
In essence, a CFD is an arrangement where the buyer and seller exchange the difference in asset prices from the start to the conclusion of the contract, without the need to actually own the asset.
BOITUMELO NTSOKO: Let’s take some questions. First up, are derivatives mainly for day traders and speculators, or can long-term investors benefit from them as well?
MABOKO SEABI: While derivatives are favored by day traders and speculators, they can also offer advantages to long-term investors.
Long-term investors might use derivatives to gain exposure to underlying assets without direct ownership or to hedge against potential losses in their portfolio, allowing them to manage risk while maintaining their investments.
BOITUMELO NTSOKO: Are derivatives suitable only for experienced investors, or can novices also engage with them?
MABOKO SEABI: Absolutely, beginners can learn about derivatives. However, it’s essential for them to seek education and practice wisely. They should familiarize themselves with effective strategies and obtain the right educational resources. Keep in mind that derivatives are complex and carry risks.
Thus, beginners should focus on building a strong foundational knowledge and might start with simpler instruments like ETF [exchange-traded fund] CFDs, which can provide access to a wider range of investments.
BOITUMELO NTSOKO: For those just entering the field, what is the main appeal of these investments? Are there certain risks they should be aware of?
MABOKO SEABI:The key draw for newcomers is the leverage that derivatives provide, allowing access to significant assets with a smaller initial investment. However, as mentioned previously, risks include losing the initial capital and the increased volatility that many derivatives entail. It’s crucial for newcomers to understand how to manage and mitigate their risks.
Listen/read: CFDs provide an element of gearing and leverage
BOITUMELO NTSOKO: Given these risks, what approach would you recommend for beginners starting to trade?
MABOKO SEABI: While I’m not a financial advisor, my aim is to assist clients in making informed investment choices. Beginners should consider starting small, perhaps focusing on ETFs, as they provide diversification and a more passive investment strategy, allowing one to acclimate to trading before venturing into individual CFD stocks.
Read: Derivatives: Alternative investment potential
This method doesn’t require substantial capital. However, as mentioned, it carries substantial risks—especially leverage, which can exaggerate both gains and losses.
BOITUMELO NTSOKO: Maboko, could you elaborate on some practical steps for beginning to trade? Perhaps a guide on account opening, broker selection, and understanding the trading process?
MABOKO SEABI: Certainly, this is a critical question since many investors skip essential steps. First, they need to open a trading account with a licensed broker. The broker should hold an FSP [financial services provider] number, authorized by the FSCA, the Financial Sector Conduct Authority, for offering derivative products. It’s crucial to research brokers to verify their legitimacy and ensure they offer the necessary tools and resources for informed investment choices.
Read: Finding the right derivatives broker
After selecting a broker, they can open their account and complete the verification process; in most cases, this can be accomplished in under five minutes. Once the account is funded, they can start learning and investing in various CFD assets available through the broker.
It’s prudent to avoid brokers who promise unrealistic returns. If it appears too good to be true, it’s likely a scam.
BOITUMELO NTSOKO: Regarding trading platforms and tools, what recommendations do you have for our investors, especially those new to this area?
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MABOKO SEABI: For individuals just starting with derivatives, many brokers offer user-friendly platforms that include educational resources.
Look for platforms that provide human support, such as an account manager to help you navigate your portfolio and comprehend your investments.
Additionally, it’s essential to remember that derivatives are used by scalpers* and short-term traders. Therefore, having charting tools is key for performing informed technical analyses. Tutorials can also facilitate the learning process, enhancing users’ understanding of the platforms.
* Scalpers quickly buy and sell securities, usually within seconds, aiming to profit from small price movements achieved through high trade volumes – Investopedia
BOITUMELO NTSOKO: Maboko, can you share a few platform recommendations for users to consider?
MABOKO SEABI: Certainly. First, we have Brokstock. We offer a wide range of tools; our app includes access to over 1,400 US companies, more than 240 ETFs for clients to evaluate, and over 160 JSE companies for potential investment.
BOITUMELO NTSOKO: Let’s shift to discussing stocks. Are there minimum amounts required to begin trading, and what should investors pay attention to?
MABOKO SEABI: The minimum amount depends on the broker and the specific type of derivative. Typically, one should be aware of fees such as brokerage fees, transaction fees, and margin costs when trading with borrowed funds; it’s important to consult your broker for a detailed overview of these fees.
Listen/read: How investment fees impact your bottom line
These should be transparently displayed. Usually, they can be found on the broker’s website, ensuring clarity regarding what to expect and what to be cautious of.
BOITUMELO NTSOKO: Before we conclude, what crucial message would you offer to beginners around derivatives trading?
MABOKO SEABI: The main takeaway is to prioritize education and fully understand the risks associated with derivatives, as they can magnify both gains and losses.
Moreover, having a strong understanding, paired with a cautious mindset, is vital for long-term success.
With that in mind, it’s important to be well-informed in both technical and fundamental analysis to navigate the trading landscape effectively. Fortunately, we now have tools like stop-loss and take-profit orders to help manage risks more effectively.
BOITUMELO NTSOKO: You previously mentioned stop-loss orders. Can you clarify this for our listeners who might be unfamiliar with it?
MABOKO SEABI:A stop-loss order is an example where if a share price is at R10, and the client purchases it at R10 but intends to avoid losses if the price drops below R9; they would place a stop-loss order at R9 to automatically close their position at that price. This is a way to minimize potential losses since losses can be substantial. Setting a stop-loss order is essential to protect against losing all of the initial investment.
These are fundamental risk management tools.
BOITUMELO NTSOKO: We’ll wrap up here. Thank you, Maboko, for sharing your insights with us today.
MABOKO SEABI: Thank you for having me, Tumi.
BOITUMELO NTSOKO: That was Maboko Seabi, senior analyst at Brokstock.
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