Why should you open a brokerage account to start trading? It is because, as Warren Buffett said, ‘If you don’t find a way to make money while you sleep, you will work until you die.’
Warren is the legendary CEO of Berkshire Hathaway Inc., a multibillion-dollar enterprise poised to join the ranks of the trillion-dollar companies within the decade. If that is not impressive enough, Berkshire Hathaway also has the most expensive stock in the world; its Class A stock (BRK.A) currently trades at over $600,000 per share.
Indeed, trading can help you build wealth. It allows you to put your money to work so you won’t have to – if you prefer not to.
What Is Trading?
Trading is buying and selling assets for profit. To be more precise, it is speculating how an asset’s price will move – whether it’s up or down – and buying and selling assets or their derivatives according to your predicted movement.
To illustrate, if you expect the price of Amazon stock to increase, buy Amazon shares. If you’re right and the price climbs, you can sell the shares you purchased. The difference between what you paid and what you sold them for, diminished by fees, is your profit.
Now, if you believe that the price of Amazon stock will decline, you can sell your Amazon shares instead. If you’re right, you can buy the same volume and get your shares back. The difference between the amount you got for selling them and what you paid to buy them back, minus fees, is your profit.
Short Selling
When you predict that stock prices will fall, you can sell assets you do not own. This strategy is known as short selling.
Short selling is taking possession of other people’s shares through a broker, selling them at the current going rate and keeping the sales proceeds in your account. If the share prices fall as you predicted, you reacquire the shares you sold and return them to your broker. Your profit is the difference between the amount you got when you sold the shares and the amount you paid when you retrieved them.
Short selling can be highly rewarding because it can let you profit from the price movements of assets you don’t own. However, it is highly risky. If your speculation is wrong, you can suffer significant losses.
You see, if you speculate that the price will increase and the price falls instead, you can only lose as much as the initial unit price of the asset. In other words, an AED 10 share can only drop by AED 10. It can become zero – i.e., worth nothing – but cannot fall any further than that. In short, there’s a limit to how much you can lose if you buy but the price declines.
It’s a different matter if you short-sell an asset. The asset’s price can rise exponentially. AED 10 can become AED 20, AED 50, AED 100, AED 1,000, or more. Technically speaking, there is no limit on how much the price of an asset can increase.
If you sell your assets because you’re expecting a downturn and that doesn’t happen, you lose only the potential value your assets would have accrued had you not sold them. However, if you short sell, you face a much bigger loss. You need to buy back the assets you sold even if they have become untenably expensive; you just borrowed them, so you must return them.
CFD Trading
You can also trade contracts for differences (CFDs) to gain exposure to price movements, even if you don’t own a particular asset.
CFDs are derivative contracts based on an underlying asset, and profits are made or lost based on this asset’s price movement. The buyer and seller of these contracts do not own the asset.
For instance, you don’t need gold investments in the UAE to buy or sell gold CFDs. In CFDs, you gain exposure to changes in the price of gold because you and another party (another trader or your broker) agree to exchange the difference between the value of gold when the contract is opened and its value by the time the contract is closed.
To illustrate, suppose you believe the price of gold will fall. Instead of borrowing gold to sell (i.e., short selling gold), you can sell gold CFDs. On a CFD brokerage platform, you will open a short position (i.e., place a sell order for shares of CFDs). You can close your position if the price falls as you speculated it would. Your profit is the difference between your CFDs’ initial and final values, diminished by fees.
However, if the price increases, you (the seller) will suffer a loss while the buyer will make money. They will close their position (sell their CFDs) and keep the difference (minus charges and commission) between the initial and final values of the contracts as profit.
In CFD trading, you buy (go long) when you predict an increasing price trend, and you sell (go short) when you believe the opposite will happen. You can also open a position bigger than your actual trade deposit.
This is because CFD allows leverage trading. To illustrate, if you can leverage up to 1:20, an AED 100 deposit lets you maintain an AED 2,000 position. In other words, you only need to pay AED 100 on a trade to buy AED 2,000 worth of contracts. If your trade pays off and your AED 2,000 position balloons to AED 5,000, your AED 100 margin effectively nets you AED 4,900 (minus charges and commission).
Leverage is a double-edged sword, however. If it goes the other way and your AED 2,000 position becomes worthless, you are liable for the entire AED 2,000. You must deposit an additional AED 1,900 (plus fees) to make good on your trade. The lesson here, therefore, is to mind how big your total position is when you trade CFDs.
Build Wealth With Trading
Trading is a wealth-building strategy. You profit by speculating on short-term asset price movements and buying and selling that asset accordingly. Alternatively, you can borrow assets and short them. You can also gain exposure to their price movements without the need for outright ownership by trading CFDs.
