Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

Using trading and investment products

Lesson 2 of 6

Combining trading and investing

When starting a company, having a well-researched business plan in place is the first step to achieving success. This plan would consider any challenges you might encounter in the future as well as potential remedies should those challenges come to pass.

Similarly, when you start combining trading and investing for the first time, it’s best to write down a formal strategy. It creates a framework that allows you to monitor your progress as a trader. You can use a strategy developed by someone else or come up with your own to test in the market.

This will help you measure the impact of your decisions, keep you from acting impulsively and help you generate enough data to see whether your plan is working.

Some market participants who trade multiple products use a core-satellite strategy.

At the heart of their portfolio sits a range of long-term financial assets. These assets are often a mix of shares, bonds, cash and other alternative asset classes such as gold, commodities and property. They’re carefully selected and spread out methodically to help reduce your overall portfolio’s risk. This is known as creating your strategic asset allocation.

This core portfolio is held for years or even decades. The expectation is that it will provide investors with positive returns over the long term along with income and dividends that can be reinvested back into the portfolio.

Over time, the economic landscape as well as the valuations for each asset class may change. For instance, growth prospects in a country may make company shares from that country more attractive, and this may give you an opportunity to allocate more funds to these type of shares in your portfolio. This is known as tactical asset allocation.

The satellite part of the strategy will usually involve introducing investments with a higher degree of volatility or price fluctuations. You can do this by buying speculative individual shares or funds, or by trading using derivative instruments.

Did you know?

A speculative share is stock from a company with a value that’s prone to high levels of volatility. This is usually because the company is young, its revenue and earnings growth might be unpredictable or it’s part of a risky industry, but it still has high growth potential.

Because these companies are characterised by greater risk with the possibility of high returns, many market participants prefer to trade them on a short term basis. However, a long-term investor could also capitalise on a stock’s low initial value and sell should the company grow.

Smart money management is key to succeeding when using this approach. It’s important to ensure that you make the distinction between money that’s earmarked for building wealth and money to be used for speculative purposes.

Using a multi-product strategy

A multi-product trading strategy involves using a combination of investment assets (like shares) and derivative instruments (like spread bets and CFDs) to build wealth and manage your risk.

Buying shares gives you direct ownership in a company. People who buy shares often do so in the hopes that the company will grow in value over time so that they can sell their shares at a higher price later.

This is called investing. You can also buy other types of securities such as ETFs, which trade just like a share. The main difference is that these funds spread your investment over a large number of stocks or bonds.

A diversified portfolio can be a wonderful wealth creation tool, but it takes a great deal of time and money for it to grow. Because share prices typically rise over long periods of time, you build wealth by holding on to shares for years or even decades and possibly reinvesting the dividends.

Using derivative instruments allows you to take advantage of shorter-term price movements. With leverage, you only need a fraction of a share’s full price to buy it – but with the added risk of losing more than your initial investment.

Short-term speculation on the price movements of financial instruments is called trading. Remember, when you trade, you can either take a long position when you think the value of the asset you’re trading will rise, or a short position when you think it will fall.

For example, a company making a surprise announcement in the wake of a scandal concerning one of its top leaders could scare off a few investors and thus drive down its share price. For a derivatives trader, however, this situation could present an opportunity to take a short position on the company’s stock to profit from its potential downturn.

Did you know?

Major economic, political and environmental events are known to cause volatility in the financial markets. In fact, keeping on top of current events is important for derivatives traders as it could give an indication about the near-term direction of a particular asset.

Here’s a quick exercise to check your understanding:

Question

ABC plc, a popular laptop manufacturer, recently launched a new and more advanced laptop model. Sales of the model have been doing incredibly well and, as a result, the company’s stock price has been rising rapidly. You want to lock in the current price before it rises any further and potentially make a profit from its near-term movement. While doing your due diligence, you find that there’s a growing microchip shortage that’s affecting production of many of the company’s products, including the newly launched model.

You think this will significantly affect the company’s bottom line in the near future. So, you:
  • a Go long on ABC plc
  • b Go short on ABC plc

Correct

Incorrect

You go short because the microchip shortage could adversely affect the company’s profits. In turn, shareholders may choose to sell their stake in the company to avoid any future losses.

This would lower its share price and subsequently its trading price. So, if the share price falls in your favour, you’ll make a profit.

Remember, several factors can influence the price of a share. So negative findings like those in our exercise might not always have this effect on a stock’s price. It’s also not possible to know when a so-called ‘price squeeze’ might begin. Traders have to keep their finger on the pulse of any market or company movements.
Reveal answer

A multi-product trading strategy is a good way to add variety to your portfolio. Because it combines less risky long-term investments with short-term volatility, you can find opportunity in various market conditions.

Lesson summary

  • A multi-product strategy combines complex and non-complex financial products to create a diverse portfolio
  • Buying shares is generally ideal for long-term investments, while trading derivatives can be useful for short-term opportunities
  • Trading with leverage enables you to amplify your earnings, but your losses could be just as amplified
Lesson complete