The growing amount of misinformation surrounding forex robots is making it increasingly difficult for the average retail trader to distinguish whether or not they are an effective means of getting exposure in the forex market. This misinformation is due largely to the fact that the internet is saturated with content from robot developers more interested in lining their pockets, than growing your trading account.
I should point out that this article is by no means an attack on the forex robot community, rather it is an unbiased perspective aimed at educating traders so you can make more informed decisions when entering the markets. By the end of this article you will know some of the important pros and cons of robots as well as ways to filter the good from the bad developers.
The developers of robots focus on a few key selling points in order to market their product effectively. These selling points have clear advantages and disadvantages and I will focus on these to help you distinguish whether or not robots remain an effective investment vehicle for yourself.
Access to markets
Forex robots provide traders access to markets 24 hours a day 5.5 days a week. Since most retail traders do not want to spend that much time in front of the computer, this is an effective way to capture more opportunities and potentially increase profits. It also allows trader’s access to a greater variety of currency pairs, more than they would be able to analyse and trade themselves.
Although they can generate more opportunities, robots do have their limitations. Robots limit which broker you use as most robots aimed at the retail community will only run on MT4. The opportunities you are then able to take are limited by the spread your broker offers for that particular currency pair, (some robots will not take opportunities if the spread is too wide). For this reason it is recommended that you chose an MT4 broker that uses and electronic communications network (ECN) feed, as the spreads are typically tighter. Another limitation of robots is the fact that they are typically run off your computer as a virtual private server (VPS), this means that they need exclusive access to your trading account and require you to keep your computer running and platform open to get continued access to the forex market 24/5.5. Usually you will have to run two trading accounts if you wish to do your own discretionary trading as well as the robots.
Built in strategy
One of the biggest challenges facing new traders is developing an understanding of the market, and then building a strategy around that understanding. This can take years and thousands of dollars to develop. Robots remove the need for traders to build a strategy or even understand the market. Assuming the robot is profitable; this may provide traders with a more cost effective way of entering the market, increasing their chances due to the robot having a superior strategy.
It should be noted that in order for the robot to be effective the owner will still have to ‘tweak’ it for optimal results. In this situation it would be beneficial to have some understanding of trading or the forex market so the parameters can be set as optimally as possible. In my opinion, it is up to the vendor of the robot to provide its customers with continued support and instructions on how to optimise the robots settings for best results.
You should also take into account ‘who designed the robot?’ was it designed by a respected company with years of market experience, or an IT guru with internet marketing experience. The long term effectiveness of the strategy of the robot will be dependent on this factor.
Trade execution
Trade order execution is paramount to your trading and ultimately profitability. Robots can be better with regards to order execution due to the speed with which they think and act across multiple currency pairs. This provides a distinct advantage over typical discretionary trading, as more trades can be executed sooner, increasing exposure and potentially profits.
There is some disparity between demo and live trading with robots, due to execution of orders further illustrating the importance of the broker you choose to run your robot with. As was said above an MT4 broker using an ECN as opposed to a deal desk would be optimal for results. Psychology
Forex robots remove the need for the owner to think when engaging in a trade. One of the three pillars of an effective trading system; psychology, is what prevents traders from turning a winning strategy into a successful and profitable system. The owner simply turns the robot on, enters parameters specific to their risk and trading profile, and the robot does the rest. This is one of the most attractive features of a robot, leaving the trader to tweak the system based on statistics and profitability rather than emotion.
Money management
Forex robots can come with built in money management profiles that can be customised to meet the traders risk profile. Most new traders enter the forex market with little or no understanding of money management, so having a robot with a built in money management system puts them at immediate advantage than if they were to begin trading on their own. The money management employed by the robot is especially important and consideration should be given to this when choosing a robot.
Market conditions
Although this isn’t a point highlighted by robot developers when typically talking about the advantages and disadvantages of robots, I think it’s important to highlight that this is one of the key reasons robots can fail. There are so many variables in the forex market giving rise to changing conditions it is hard for robots and their developers to keep up. Robots for example a robot cannot detect when there is thinner liquidity giving rise to sudden sharp price movements, or breaking news causing volatility. As humans we can make ourselves aware of these factors and adjust our approach immediately.
When there are so many variables affecting currencies at any one time giving rise to market change and volatility, it seems almost impossible that a piece of software could possibly factor in all these changes to remain profitable and the strategy valid. Because of this robots are inherently designed to fail. This problem can be corrected if the robot is constantly updated and the strategy refined to adapt to changing market condition.
Cost
The last point to consider is cost. With robots, like anything in life, you get what you pay for. More expensive robots are likely to have more research and development behind them. While a support team will help you get setup and customise the robot to your settings, as well as provide you with updates. The less expensive variety has online manuals, placing the onus of tweaking the settings of the robot on the trader.
When considering the price of the robot, remember what it is you are buying and the costs associated with the alternative. The alternative, is spending thousands of dollars and hours educating yourself about the forex market and then, trading by yourself with no guarantee of success.
As you can see above, forex robots are not a sure road to success in the forex market. They have their obvious advantages and disadvantages, but in the end it is the job of the trader to take into consideration these points and question whether it still represents a viable way of getting exposure in the forex market.
It is important to note the reason forex robots have gained so much popularity is because there is a lucrative in selling them. The marketing teams behind robots sell hopes and dreams, which for the most part is what the average retail forex trader desires. They represent an easy solution to tradings biggest problem, making money.
If you take anything from this article, let it be the fact that it is essential to have at the very least a basic understanding of the forex market and trading before engaging in any sort of trading, even through the use of a robot. If a trader is going to use a robot I would suggest doing your homework and finding out the following: who made the robot, their experience in the markets, years developing robots, support staff if any, do they help you optimise the robot, live trading account results, as much information about the strategy and money management system as possible and how many markets it covers. Once you have this entire information look at the costs. If a company can’t provide you with this information they aren’t worth your time or money!
To find more helpful infomation on Forex trading you can download our free Forex Guide.
The leverage CFDs offer makes day trading attractive, however, before commencing a day trading strategy you should asses the benefits and downside to using CFDs.
Below are some of the benefits of using CFDs in your day trading strategy:
Low Commission
The commission rates on share CFDs are much less than on traditional shares, this means that you can trade more actively for smaller price movements making CFDs extremely cost effective for day traders.
No financing charges If you do not hold your CFD position open overnight you will not incur any financing charges
Risk minimisation
You are not exposing yourself to the risk of a stock or share CFD gapping up or down overnight as a result of global market movements.
Free cash flow As you are only holding your positions for a short time frame you are not locking up you cash, this means that when you see a trading opportunity you will have sufficient funds in your account to place the trade.
Although there are many advantages of using CFDs in your day trading strategy there are also some downsides, these are listed below:
Time
As all of your trading will occur during market hours over short time frames you need to monitor your trading screen on a regular basis, this process can be time consuming.
Decision making
As time is of the essence in day trading it is important to have a very good idea about your trading system as you will have to make quick decisions about your trades.
Capital outlay Day traders focus on profiting from smaller price movements, therefore in order to make large amount of money, it is necessary to start off with a bigger float or use more leverage.
If you have the time, a good intraday strategy and can afford to start trading with a larger float, then day trading may be the right trading style for you. Before rushing out, opening a CFD account and becoming a day trader you should consider the following tips:
Trading CFDs is very much like running your own business, however, as CFDs are leveraged, there is a chance of losing more than your actual deposit, using stop loss orders and having a good money management plan will minimize this risk.
Before starting to trading, ensure that you understand and stick to your trading strategy. You should start by practicing your trading system in a demo account.
All traders will have both winning and losing trades. Trading a profitable trading system is the most important factor in making profits overall. It is likely that when you start out trading you will have some loosing trades. However, despite the fact that the number of losing trades is often more than the number of winning trades, the size of the winners are generally considerably larger than the losers. In order to make consistent long term profits, you need to properly back test and understand your trading system.
Measure the performance of your trading system, you need to look at its profits as a percentage of your initial cash float, the maximum historical drawdown as a percentage of your initial cash float, the steadiness of returns, and the profit-loss ratio combined with the win-loss ratio.
Choose your CFD provider carefully. Each CFD provider offers a different number of CFDs some of which are short sellable and others not. The trading platform each provider uses determines the type of orders that you can use in your trading strategy. You will need to consider all of these issues as they may have an impact when back testing your trading system.
To find more helpful information about day trading CFDs you can download our free CFD Guide.
It is becoming increasingly popular for trustees of self managed superannuation funds (SMSF) to use leverage in order to magnify returns by investing in derivatives such as Contracts for Difference (CFDs). The Australian Taxation Office (ATO) defines CFDs as “synthetic financial products that enable investors to access the price movement in shares and other instruments such as stock indices, stock options, currencies and futures contracts without owning the underlying product.”
The ATO sates that a SMSF should only enter into derivatives transactions, if the purpose is to hedge and not speculate; and the SMSF has a risk management strategy (RMS) in place.
The ATO Interpretive decisions released on 29th March 2007 tries to distinguish between the two types of CFD transactions which are available in the market. One type requires the investor to place an amount on deposit with the CFD provider, and the other type requires the investor to pledge other assets of the investor.
Both types of CFD transactions are explained in detail below.
Type 1
The ATO’s interpretative decision 2007/56 states that where the purpose of the investment is for hedging only and there is no pledging of other assets of the investor, investing in CFD’s by a SMSF will be considered within the rules of SIS Act.
The ATO states their reasoning for this as because there is no loan between the CFD provider and the SMSF trustee and therefore no contravention of the prohibition on borrowing by trustees in section 67 of the SISA. The requirement to pay a deposit and meet margin calls does not represent borrowing; they are rather contractual liabilities to make payments if and when required and are not repayments. The obligations in relation to CFDs are distinguished from margin lending through a broker's margin account in relation to the purchase of shares by an SMSF, which does represent a prohibited borrowing under the SIS Act.
The operation of the CFD bank account and the obligation to pay deposits and margins does not create a charge over any assets of the fund. The parties are relying on the contract and not on any security interest to be created by the contract. Under the CFD, the monies in the CFD bank account are the property of the CFD provider and the fund (investor) has no beneficial interest in the account. (Trustees need to examine individual product disclosure statements and contracts to ensure that there is no charge made over an asset as prohibited in regulation 13.14 of the SISR and that all requirements of the SISR and SISA are adhered to.)
The investment is in accordance with the fund's investment strategy as required under paragraph 52(2)(f) of the SIS Act and regulation 4.09 of the SIS Regulations. “
Type 2
The ATO’s interpretative decision 2007/57 states that immaterial of the fact that hedging may be the sole purpose for investing in CFD’s, if the CFD provider requires the investor to pledge other assets of the investor then investing in CFDs by a SMSF will be considered outside the rules of SIS Act. Should this occur the trustee of a SMSF has contravened subsection 34(1) of the SIS Act and has breached the prohibition against trustees giving a charge over, or in relation to, fund assets. The interpretative decision is outlined here ATO ID 2007/57.
ATO’s reasoning for this decision is:
“However the trustee and the CFD provider entered into a separate written agreement under which fund assets were deposited with the CFD provider in fulfillment of the fund's obligation to pay margins. Regulation 13.14 of the SISR prohibits trustees from giving a charge over, or in relation to, an asset of the fund. This regulation is an operating standard for regulated superannuation funds under section 31 of the SISA. Subsection 34(1) of the SISA requires that the operating standards are complied with at all times. The terms of the agreement stated the circumstances in which the fund's assets would be realised, and showed an intention to create a charge over the assets. By entering into the agreement with the CFD provider the trustee has contravened subsection 34(1) of the SIS Act.
Regulation 13.15A of the SIS Regulation, which allows trustees to give a charge over fund assets in relation to options and futures contracts in accordance with the rules of an approved body, and in accordance with the fund's derivatives risk statement, does not apply. A CFD is not an options contract or a futures contract, and the charge was not given in relation to the rules of an approved body.
The trustee has therefore contravened regulation 13.14 of the SIS Regulations and consequently subsection 34(1) of the SIS Act.
In Conclusion As a trustee of a SMSF prior to making an investment in CFDs the trustee must consider the following:
1. Does the trust deed allow for investment in derivatives (CFD's);
2. If derivative investments are acceptable the trustee must only deposit cash as margin; and
3. There must be a Derivative Risk Management Strategy (RMS) in place.
If it is found that your SMSF is not complying with the rules your auditor may lodge a contravention report meaning that your fund may become a non-complying fund in an ATO audit.
For more helpful information on CFDs and Superfunds you can download our free CFD Guide.
A CFD or Contract for Difference is a type of derivative contract taken out between two different parties, the buyer and seller. The seller has an obligation to pay the difference between current price of a specific share or other instrument over which the CFD is based and the price at the time of selling the contract to the buyer. Should the difference be negative (a loss), it works the other way round where the buyer pays the negative difference to the seller.
CFD trading began in London in the 1990s. It was only in 2001 that investors realized that Contracts for Difference had advantages over traditional share trading, the main advantage being the avoidance of stamp duty.
CFDs have a number of advantages in that no CFD contract expires and the owner of a CFD is required to only maintain minimum margin meaning a low capital outlay is required, this is very different to traditional share trading where the full value of the position is required upfront. It is essential that CFD traders calculate their risk tolerance and study market trends on regular basis to avoid margin calls which can occur should the CFD position move against them. CFD traders can also go short and use stop loss orders enabling allowing them to minimize losses.
There are many types of financial instruments available allowing investors to outlay a relatively small amount of money in trade. Depending on the level of knowledge an investor has they will choose the relevant financial product to suit their needs. If we compare all types of financial instruments Contract for Difference trading is most similar to futures trading with the added benefit of liquidity and leverage.
Below are four of the main benefits of CFDs:
1. Financing Rates
CFDs incur a financing rate when you hold a position overnight. The financing for long positions is typically the Reserve Bank rate or cash rate plus a premium. So if the Reserve Bank rate (RBA) is 4.25% then you pay 6.25% per year calculated daily as the CFD provider will typically add a 2% haircut on top of the RBA rate. The financing rate for CFDs is typically much less that that charged by margin lenders.
2. Leverage Leverage is one of the main reasons CFDs have become so popular. Leverage works like this, imagine you had $5,000 in a share trading account you could only trade up to $5,000 and a 5% move on $5,000 would only be $250. If you took that same $5,000 and used it to trade CFDs you could open a $20,000 position, that same 5% move now equates to $1,000. Using the CFD you can have potentially made another $750 with no additional outlay.
3. Liquidity One of the most important aspects of CFDs is liquidity. Unlike other derivative products such as options, CFDs directly mirror the liquidity in the underlying market. When trading with a CFD provider using a Direct Market Access (DMA) model you can see the exact volume available in each stock at each price level in the market depth, you are also able to participate.
4. Low Commissions
The most significant advantage of CFDs are their low commission rates, some of the CFD products such as index CFDs are even commission free. Typically CFD brokers charge a minimum of $10 or 0.1% for share CFDs.
You can learn more about CFDs and their benefits in our free CFD Guide.
A Contract for Difference (CFD) is a derivative that allows you to speculate on the price movement of underlying securities such as shares, indices and commodities over which the CFD is based without the need to own the instrument.
In simple terms a Contract for Difference is a short term contract between the buyer of the CFD and the CFD provider, with both parties taking an opposite view as to whether the value of the underlying security or instrument over which the CFD is based will increase or decrease in value. CFDs are settled in the form of a cash payment which is calculated as the difference between the opening and closing value of the underlying security or instrument. If the difference is positive the CFD provider pays the difference, and the holder of the CFD will profit. Should the outcome be negative, the holder of the CFD must pay the difference to the CFD provider, and the holder will incur a loss. As CFDs do not have an expiry date CFD positions can be held open indefinitely.
The Australian Taxation Office (ATO) has published a Tax Ruling TR-2005/15‘Income tax - tax consequences of financial contracts for differences’, relating to the tax treatment of financial Contracts for Difference.
The Tax Ruling states that if you are carrying on a business (or entering into commercial transactions) of buying and selling CFDs for the purpose of profit making, any gains made will be regarded as assessable income and any losses incurred will be an allowable deduction. The deciding factor here is whether you are in fact carrying on a business (or entering into a commercial transaction) the main tests to determine this are outlined below:
The number of transactions you enter into each year (e.g. on a weekly or monthly basis);
The size and scale of your operations;
Whether you are carrying on your activities in a systematic, organised and businesslike manner for the purpose of profit making; and
The degree of skill employed in performing these activities.
If you determine that you are not carrying on a business (or entering into commercial transactions), any gain or loss you would normally make would fall under the Capital Gains Tax (CGT) provisions. As CFDs are regarded as a CGT-asset, any capital gains are treated as assessable income and capital losses can be deducted from any current or future capital gain.
As the ATO views Contracts for Difference as contracts of speculation, in that you are effectively betting that the underlying security or instrument will either increase or decrease in value, it would seem from the ruling that the aforementioned many not apply to CFD transactions. If this is the case, any capital gain or capital loss you make ‘from a financial Contract for Difference entered into for the purpose of recreation by gambling’ will be disregarded under the CGT gambling exemption provision.
What this all means is that if you have made a $1,000,000 capital gain from a CFD trade and you can persuade the ATO the transaction was entered into for the purpose of recreation by gambling, you will be laughing all the way to the bank. However, if the outcome were a $1,000,000 capital loss, you would lose the ability to offset the capital loss from any current or future capital gains that you may have.
As the ATO views that Contracts for Difference are predominantly entered into for a profit making or gambling purpose, it will would difficult for you to claim a capital loss if you could not prove that you are carrying on a business or entering into commercial transactions.
To find more helpful information on CFDs and tax you can download our free CFD Guide.
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