Today if some of you don't know it's my birthday (Feb 23) ! I'm turning 32 years old and i would like show you how to initiate a proper investment strategy. First of all let's choose a instruments, whether its a Indexs, commodities, stocks or Bonds. Then will choose CFDs as a investments vehicule. Investment vehicule are listed on the top right corner of this page, there is more like Binary Options but i will write about them another day. I'm going to explain today common mistakes investors or traders makes when trading CFDs.

First of all, we will initiate a "Demo account" with the investment vehicule CFD's (Contract for Difference) and to make it realistic we will only have a $25 000 Demo account. The main reason i initiate such of small account is because when you trade CFD's you don't have as much liquidity because your counterparty is a brokerage firm also called CFD providers as opposed to Exchange. They use hedging strategies to try to fullfil your positions. Now many of us will wonder what kind of protection do we have if they fail to provide liquidity. Well the anwser is, financial policies are in place to protect the brokerage firm from going out of business. For exemple CGITrading.com insure your capital up to $60 000 in case the firm was having financial issues. Other policies are in place in case the firm may not be able to fulfill your transaction. So as a exemple if you had a $400 000 CFD account and you Shorted the S&P500 and gain 400 points on the down side with a $4 million dollar position using a 10 : 1 leverage, the CFD provider may not be able to fulfill your gain of +$879 000. Don't forget CFD offer a 100 : 1 ratio on several commodities and index's, not as much on stocks which varies between 20 :1 to 3 :1.

The whole system is in place to protect the CFD providers from big Sharks and to protect somehow a part of our capital, but the systems is not perfect. They have policies in place and in fact there is no garantee that in case the firm go bankcrupt that you will get all your money back even if they told you you had a $60 000 capital insurance. This is again the worst case scenario, so look for a long trusted CFD provider like Varengold BankFX a German Bank, the offer the most capital insurance i came across up to $100 000.

Remember, there is no other investment vehicule that will offer you a 100 : 1 leverage ratio for Short selling or Buying any Index's, Commodities or Stocks other than CFD's. The original business of these CFD provider was based on FX Currencies offering a 400 : 1 leverage ratio. A quick note between FX Currencies trading as opposed to Commodities, Index's and Stocks is the spread difference, when you are talking about Currencies spread 75 pips is $0,0075 compare to trading other Instruments than Currencies a 75 pips spread would be $0,75. If you bought for $500 000 of S&P500 at 1820.75 points and the bid is 1820.00 points it may not seems like alots but you just entered a -$205 losing position and are using $5000 margin requirement from your account. With the same scenario if the index was to fall 35 points you would be sitting with a loss of (-$9611) all this with a one days movement by not using a stop loss. You would be already strugling because your account would only have $10389 free margin.

Now i understand this would be a very agressive position within the market and considering that we only have a $25 000 account we are now sitting with $10389 free margin in our account. This mean that we either don't close our position (to prevent losing 9611$) in hope the market come back at least 10 - 20 points and by waiting we are also 37 points from getting our account wiped out (Closed). We are in trouble.. Now we start by looking the $VIX or $VXV Volatility indicator of Options to see if we are facing high volatility market these days. The scenario is in place to show you that if we knew about the Volatility Indicator we would have avoid such of agressive position at first. The $VXV calculate the S&P500 Options Volatility Pricing for the near 3 month term. Though many may argue that since the calculation of these Volatility Indicator is recalculated on a day to day basis from the Options Pricing that they are not always relevant. See the Volatility chart from Tc2000.com below as a reference for your future investment decision.

What these two charts below means is that the symbol $VXV (from www.stockcharts.com) move higher and higher when the Options pricing of the S&P500 near term 3 months are Volatile. This means Options tend to be Volatile when there is market uncertainty, and again many may argue these calculations are not directly related i beleive they makes perfect sense.

Also I could have used the $VIX which is a gauge of expected volatility for near 1 month term of the S&P500. Instead i used the $VXV which tells us more about the near 3 month of the S&P500. Just so you know these index are tradeable on the Chicago Board Of Exchange CBOE. Hedge funds managers used them to Hedge their portfolio position from high volatility markets, instead of withdrawing their investment if they expect a volatility near 1 month or 3 month then will buy Options (Call or Put) or buy or sell Futures from the $VIX and $VXV. These Volatility Index are tradeable as Options or Futures on several instruments. These Volatility index are for Hedging positions they should not be used as primary investment since they only have a 60 days or 90 days expiration and in order to make money you need to buy these Options or Futures before the volatility prices become Embedded in the value pricing. Check out this link : http://finance.yahoo.com/news/vix-ratio-shows-more-long-170852008.html

If you look these two chart below, you should be very carefull when trading the S&P500 while the Volatility trend line are high otherwise you risk to hit your stop loss several times in a row, which will vanish your account due to volatility.

Louis Gosselin
Equity Strategist