The pandemic has accelerated the growth in online trading globally. It is estimated that millions of first-time traders have entered the markets in the last 2 years.
The trading of Meme stocks like the ‘Gamestop’ stock by ‘Reddit Traders’ is an example of how the retail trading community is now fighting back against the big hedge funds.
The ease of access via the internet is one of the reasons why many young retail traders are flocking to trading via their smartphones. But many of the new traders are trading risky instruments which they don’t fully understand,
Most brokers don’t properly warn about the risks, while some even tell you how ‘easy’ trading is. This is very risky for obvious reasons.
Online Trading is not Investing
Before we go further, we need to differentiate between trading and investing because people confuse the two.
Trading is when you buy an asset with the intention to sell as soon as the price appreciates. Traders hold securities for less than one year and sometimes a few hours.
Online trading can be carried out in many markets like stock, forex etc.
Investing on the other hand is when you buy and hold an asset with a view to benefitting from it in the future when it grows. Investors hold securities for more than one year. This is not to say investors don’t sell, but they could sell an asset when they want to realign their investment portfolio and not for a quick profit.
Investors are mostly found in the stock markets. For example, an investor who buys the shares of a company is the part owner of that company. A stock trader on the other hand is only looking to profit from the rise or fall in prices of a stock.
How does Online Trading work?
A trader who is trading in Canada needs a licensed broker to carry out trading. A trader generally goes through the following procedure.
You will find that all these steps are really simple as the brokerages try to encourage traders to sign up & trade a lot. But this Is very risky. But, let’s first see the steps involved.
#1. A Brokerage Firm
IIROC is the Investment industry regulator in Canada. All brokerage firms that accept clients from Canada must be licensed with them.
#2. Open a trading account
Most brokers offer different accounts.
For example, a broker can allow you to open individual, joint or corporate accounts at brokers. You are normally required to upload the following documents on the trading App for KYC:
- Means of identification- International passport (must be translated if not in English or French languages), driver’s license, enhanced driver’s license, Canadian military identification card, government issued ID card etc.
- Proof of address
- Signature specimen
Once you fill out all the documentation and upload the above documents, verification will take place, your account will be approved and you can go live.
#3. Fund Account
This is pretty straightforward. The money in your account will be used for trading. Most Canadian brokers allow funding your trading account via debit/credit card or via wire transfer.
#4. Place trades
After you fund your trading account, you can place orders.
For example, if you’re trading stocks, the Toronto stock exchange has over 2,231 listings to choose from.
You can buy stock of any company and keep your position open till the price increases then you sell the stock and make a profit.
For those trading forex, your broker will require you to make an initial margin deposit into your account which you can use to start trading.
The amount of initial margin may depend on the volatility of the currency pair you are trading, the type of account you are operating (whether Gold, standard, etc.), IIROC margin requirements at the moment (which changes from time to time) etc.
What could go wrong?
There is actually a lot that could go wrong.
#1 Scam Brokers
Safe Forex Brokers Canada in their research found that there are many scam brokers that target investors in Canada. These brokerages trick investors into depositing funds with them promising them returns from the markets.
A common practice of these fraudulent brokers is that they will tell investors that they have a strategy to make high returns from Forex, Cryptos, or Robo Advisors. You must not fall for these scams.
The only way to be sure that your funds are safe is to deal with brokers with domestic licenses issued by the IIROC. If you have an account with an IIROC licensed broker, you stand to be compensated by the Canadian Investor Protection Fund (CIPF) if your broker becomes insolvent.
The first factor to consider is whether the broker is licensed.
Before you pick a broker, go to the regulators website and run a check. Do not depend on online chatter, or believe what someone else tells you; just run the check yourself.
To carry out the check, visit www.iiroc.ca & Scroll down to “dealers we regulate”, type in your broker’s name in the search box and click on the “APPLY” button.
If the broker is licensed by IIROC, their name will populate on your screen carrying other information such as: Office address, phone number, and website address. Be sure to use the phone number and website address shown you on the IIROC page, if you need to contact the broker or visit their website.
The second factor to consider when choosing a broker is their customer service.
Try sending them a mail and see how fast they respond or try their live chat service to see how responsive it is. You could also pay them a visit to their office, to see how they treat their customers.
The third factor to consider is fees.
A scam broker could charge exorbitant fees, and eat up all your deposits in trading fees itself.
Some brokers charge inactivity fees as high as 150 CAD for not using your account for a while. Others may charge fees for withdrawals, and other services. There are various websites that compare fees charged by brokers. You could visit them to compare fees, and spreads.
The fourth factor to consider is risk management.
Ensure the broker offers some risk management tools such as stop loss orders, limit orders, guaranteed stop loss orders, negative balance protection, etc.
#2. Loss of Money
Online trading is risky. There is no industry stat that is common, but many experts say that most of the retail traders lose their money.
Trading is not easy, and carries multiple risks.
One of the major risks is that the market could go against the direction of your trade, and you could lose the amount invested in a trade. The situation could be worse if you are using leverage to increase your profits, as this will result in bigger losses.
It is almost impossible to predict where the markets will go next.
Expert traders will tell you that risk management would save you from losses. Let’s look at what that is.
Risk Management
While trading, experts will tell you to manage your risks. Otherwise, you could lose all the money you have in your account, and even more.
There are some practices which traders use, like the stop loss orders and guaranteed stop loss orders that your broker should make available.
If you don’t manage your risk, you could lose all your capital and if your broker doesn’t have ‘Negative Balance Protection’ (NBP) in place, you could end up losing even the loan you took (for margin accounts).
This is very common in leverage forex trading.
For those who borrow money from their broker to trade, NBP ensures you lose just your own money and not the money borrowed to you by the broker. However NBP is implemented by your broker and not every broker has it in place.
What do brokers offer for risk management?
- Stop loss orders – This is an instruction you give to your broker to close your open trading position and sell off your assets (or buy assets) once the price of the assets crosses a certain point known as the stop price. This ensures your losses are limited to the stop price you set.
- Guaranteed Stop loss orders (GSLOs) – This is sort of an improved version of regular stop orders and they come with a guarantee that no matter how volatile the market is, your stop loss order must be executed at the stop price you specified and not at any other price.
Stop loss orders are basic protection, and will only take you out of a position, and cap losses on a trade. But this is by no means an indication that you could not lose your money.
Excessive Risk
The ease of access with which you can open a trading account has probably led to so many young retail traders trading online. But most of them lose their capital very quickly.
Trading is not investing. The risk of losing money in online trading is very high, and the complex nature of some of the instruments available on trading apps which are not suitable for retail traders, makes it even riskier.
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