KEY POINTS:
Many investors have groaned in the past couple of weeks as share markets around the globe have fallen.
It's a depressing thought to see a stock which last year was valued at $12 a share fall to $10 even if it's only a paper loss.
But not all
investors have been taking a bath - some have been profiting from the falling markets through shorting. Essentially, the process involves the person believing that a particular stock, index or currency will go down.
They sign a contract to borrow more of whatever it is they want to trade from another party and promise to give it back at a certain date.
The investor then sells the borrowed shares at the current rate and repurchases them at the lower rate, pocketing the difference and returning the shares to their owner.
But like any investment it's not without risks. If the stock or currency or index does not go down in the specified timeframe and instead goes up, the investor will have to buy back the shares at the higher price and pay the difference.
It's not easy to know when exactly a company's price will fall and some troubled companies continue to go up for some time before they drop off.
It's not a practice commonly used for shares in New Zealand by individual investors, although currency trading is more popular.
Investors can also short the market without actually buying and selling the underlying shares, index or currency through contracts for difference (CFDs). There are only two companies in the country which give access to CFDs - CMC Markets and OM Financial, although Kiwis can sign up to use them with any provider around the world because all the trading is online.
CMC Markets New Zealand general manager Sargon Elias says volatility in the markets has provided plenty of opportunity for traders to make money. "That's really what our traders are looking for. They can make money very quickly in a volatile market.
"Since the sub-prime crisis kicked in last year the markets turned and the pattern has been basically downwards. It has gone from a firm bull to a bear. Traders can make money on this by taking a short position or a bet that the stock will fall in price and only hold it for a couple of days. The more volatile, the better."
CFDs were invented in Britain around 2000 and were attractive to individual investors who wanted to avoid paying fund manager fees and thought they could do better in selecting winning or losing stocks.
There is a thriving market around the world for them, but in New Zealand only a small number of people use CFDs, although Elias says it is growing slowly. "In New Zealand people are not used to having shares as an investment. For share owners CFDs are not a big step up. It has been a different education process for us - we have to do a lot on how markets work before we can get down to how CFDs work."
He says many Kiwi traders use it to gain access to overseas shares and markets. Most of the traffic is in US, Australian and UK market indices.
Kiwis are very international and outward looking, he says, a reflection of the small size of the local market.
To set up an account you need to have a $1000 balance in the CFD account. To open an account you have to have ID and CMC also do a risk check to see that people have the income to pay and savings.
They also check to see whether they understand the risks involved. "We don't sign people up who are going to go into debt."
The software is then given to the trader for free. CMC earns its money from commissions on trades and interest on money invested overnight through them - the interest is the equivalent of the reserve bank rate plus 2 per cent, currently 10.25 per cent. But if its advice you are looking for CMC is the wrong place to go - they don't offer any, they only give access to trade the markets.
"We are not here to provide advice, we are here to provide the cheapest, easiest access to any market in the world," says Elias.
The risk is very much at the high end of the scale and is significantly magnified by the fact that the trades are made on margin - if you want to trade $10,000 worth of Telecom shares you may have to put up as little as 3 per cent of your own money - but if you make the wrong call, you will have to pay out for the loss on the full $10,000.
There a no capital guarantees and every likelihood you may not even break even let alone make money.
"This is right at the top end of the risk curve, it's not a place to park your money. It's just you against the markets. It's about being intelligent and disciplined."
People can make a lot of money but Elias says success is more about whether you keep the money in the long run.
"Markets are all fear and greed. For traders it's about controlling that."
