https://iframe.iono.fm/e/1512250″ width=”100%” height=”126″ frameborder=”0

You can also listen to this podcast on iono.fm here.

BOITUMELO NTSOKO: Today, we are diving into the world of derivatives. Although it may seem intimidating, this financial instrument can be incredibly useful in the right hands. We’ll break down how derivative trading works, its purposes, and the essentials for getting started. I’m joined by Maboko Seabi, a senior analyst at Brokstock. Welcome to the show, Maboko.

MABOKO SEABI: Thanks for having me, Tumi.

BOITUMELO NTSOKO: To start, can you explain what a derivative is in simple terms?

MABOKO SEABI: A derivative is a financial contract whose value is derived from an underlying asset like stocks, commodities, or currencies.

There are several types of derivatives, with the most common being CFDs, options, futures, forwards, and swaps. However, many people mainly engage with CFDs, or contracts for difference.

In essence, a CFD is an agreement in which the buyer and seller exchange the difference in asset prices from the beginning to the end of the contract, without actually owning the underlying asset.

BOITUMELO NTSOKO: Let’s address some inquiries. First off, are derivatives primarily 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 serve long-term investors.

Long-term investors might utilize derivatives to interact with underlying assets without having to own them or to hedge against potential losses in their portfolio, thus managing risk without selling off their investments.

BOITUMELO NTSOKO: Are derivatives only for experienced investors, or can newcomers handle them too?

MABOKO SEABI: Newcomers can definitely learn about derivatives. It’s crucial for them to seek education and practice carefully. They need to familiarize themselves with the appropriate strategies and acquire useful educational resources. It’s important to remember that derivatives are complex and come with risks.

Therefore, beginners should build a strong foundational knowledge and perhaps start with simpler instruments like ETF [exchange-traded fund] CFDs, which provide exposure to a wider range of investments.

BOITUMELO NTSOKO: For those just entering this field, what would be the main attraction to these investments? Are there particular risks they should be aware of?

MABOKO SEABI:The main draw for beginners is the leverage that derivatives provide, which allows them to access substantial assets with a smaller initial investment. However, as previously noted, the risks include potential loss of the initial investment and the increased volatility that many derivatives possess. It’s crucial for newcomers to learn how to manage and mitigate their risks.

Listen/read: CFDs provide an element of gearing and leverage

BOITUMELO NTSOKO: Given these risks, how would you recommend that they start trading?

MABOKO SEABI: To start, while I’m not a financial advisor, my intention is to help clients make educated investment choices. I suggest beginners start small, ideally with ETFs, as they offer diversification and a more passive investment strategy, allowing them to become accustomed to trading before moving on to individual CFD stocks.

Read: Derivatives: Alternative investment potential

This method does not require a large amount of capital. However, it does carry considerable risk—especially leverage, which can amplify both gains and losses.

BOITUMELO NTSOKO: Maboko, can you outline some practical steps for starting to trade? Perhaps a guide on how to open a trading account, choose a broker, and understand the trading process.

MABOKO SEABI: Absolutely. This is a critical question as many investors overlook important steps. First, they should open a trading account with a licensed broker. The broker must hold an FSP [financial services provider] number, licensed by the FSCA, Financial Sector Conduct Authority, to offer derivative products. It’s essential to research brokers to ensure their credibility and that they have the necessary tools and information for informed investment choices.

Read: Finding the right derivatives broker

Once they’ve chosen a broker, they need to open their account and complete the verification process; in most instances, this can be done in under five minutes. After funding the account, they can begin learning and investing in various types of CFD assets offered by the broker.

It’s best to avoid brokers promising unrealistic returns. If it seems too good to be true, it probably is a scam.

BOITUMELO NTSOKO: In terms of trading platforms and tools, do you have any recommendations for our investors, especially those who are new to this space?

MABOKO SEABI: For those just beginning their journey with derivatives, many brokers offer user-friendly platforms with educational materials.

Look for platforms that provide human support, such as an account manager who can assist you in managing your portfolio and understanding your investments.

Additionally, it’s important to recognize that derivatives are often used by scalpers* and short-term traders. As such, having charting tools is vital for making informed technical analyses. Tutorials can also streamline the learning process and enhance understanding of the platforms being utilized.

* Scalpers buy and sell securities rapidly, usually within seconds, aiming to profit from small price fluctuations achieved through large volumes of trade – Investopedia

BOITUMELO NTSOKO: Maboko, could you also suggest a few platforms that individuals can consider using?

MABOKO SEABI: Certainly. To begin, we have Brokstock. We provide access to numerous tools; our app features over 1,400 US companies, more than 240 ETFs to consider, and over 160 JSE companies for potential investments.

BOITUMELO NTSOKO: Now, turning to stocks. Are there minimum amounts required to start trading, and what should investors keep in mind?

MABOKO SEABI: The minimum amount varies depending on the broker and the type of derivative. Typically, one should be aware of fees such as brokerage fees, transaction costs, and margin expenses if trading using borrowed funds; always consult your broker for a detailed breakdown of these fees.

Listen/read: How investment fees impact your bottom line

These should be clearly disclosed. Usually, they can be found on the broker’s website, making sure you understand what you’re getting into and what to be cautious of.

BOITUMELO NTSOKO: Before we wrap up, what is the key takeaway you would give to a beginner regarding derivatives trading?

MABOKO SEABI: The essential takeaway is to prioritize education and understand the risks associated with derivatives since they can amplify both gains and losses.

Therefore, having a solid understanding paired with a cautious approach is vital for long-term success.

Therefore, individuals should become proficient in both technical and fundamental analysis to fully grasp the trading environment. Fortunately, we now have tools like stop-loss and take-profit orders to aid in effectively managing risks.

BOITUMELO NTSOKO: You just mentioned stop-loss orders. Could you clarify this for our listeners who may not be familiar with the idea?

MABOKO SEABI:A stop-loss order is, for example, when a share price is at R10, and the client purchases it at R10, but they want to prevent it from dropping below R9; they would place a stop-loss order there to automatically close their position at that price. This helps in minimizing potential losses, as losses can be amplified easily. Setting a stop-loss order is crucial for protecting against losing the entire initial investment.

These are vital risk management tools.

BOITUMELO NTSOKO: All right, we’ll conclude here. Thank you, Maboko, for joining us today.

MABOKO SEABI: Thank you for having me, Tumi.

BOITUMELO NTSOKO: That was Maboko Seabi, senior analyst at Brokstock.

Listen to previous Money Rules podcasts here.

Stay updated with Moneyweb’s comprehensive finance and business news on WhatsApp here.