Risky Move - Contra Trading

No, No.. Cool game but we're talking about Contra Trading larr....

Contra? You mean that uber awesome tv game we used to play as kids!

I'm afraid not! I am referring to how I made a contra sell the last few days.

Let me explain:

Contra trading is when you purchase and sell stocks by not putting the actual money down. Online brokers give you 3 days from the day you purchased it (known as T+3) to put the money down for the purchase (including brokerage fees).

If not, they will force sell it on (T+4) for you and charge you for any losses made. But the upside is if it did go up within those 4 days, you profit.

What happened for me was I have been eyeing Masterskill Education Sdn Bhd (Ticker: MESB - http://www.bloomberg.com/apps/quote?ticker=MASEG:MK). It has been a stock I already have a small holding of it and have been eyeing since it had dropped to an all-time low of RM 2.03 since its IPO debut last year or RM3.80. I was thinking of increasing my holdings believing in Education and how undervalued it is to its peers (HELP and SEGI) but also took into account the concern over PTPTN loans funding its students were in trouble.

So, I bought 6 additional lots at RM2.12 on Monday for long term holdings but for research purposes I thought I would let it force-sell to see what will happen given it rocketed up to RM2.40+ the next few days.

Eventually, Friday (T+4) came and I got a call around 9am from CIMBiTrade inquiring whether had I paid for the stocks and they would force-sell it by noon if I don't force-sell it myself.

I did do so and sold them at RM 2.44 to make a quick tidy but small profit of RM 100+ (yes, force-selling does incur brokerage charges)

Ok, the reason why I relate all this to you is to give a very real example but NOT to say yes you WILL make money contra trading. Most contra traders actually lose money!

By saying I will buy at RM2.12, I have to pay within 3 days. If I don't, up or down, I pay for brokerage fees and any losses! Noone can really tell if a stock will go up in 3-4 days. While MEGB was deeply undervalued, it could have plunged further or what is stopping a plunging stock from plunging further (think: winding up, fraud, etc)

If you're banking on some news like say a takeover, some takeovers don't happen for whatever reason, the price plunges, and you're stuck with a stock with a loss!

Let's go through all the risks involved:

1) If the stock plunges, you have to pay for all the losses not made back by the broker's force sell.

2) If the stock is suspended (it can happen) or suddenly for whatever reason de-listed, you can't sell, you still owe the bank RM X which you have promised to pay legally. This may incur high interest rates until you can pay it off on top of the losses/profits made later from the sale.

3) You may have no control on how much to sell (but in my case, I did because the bank gave me until lunch time to force sell it myself.. I am not sure how often this is the case)

4) Brokerage fees will kill you in the wrong run! Day trading or Contra trading - You will incur lots of brokerage fees! Take my example - you would think 600*(2.44-2.12) = RM 192 profit! Nope - Brokerage fees (including stamp duty) was 56.67 - So I only made RM 135.33 (30% of my profit loss because of brokerage). In the long run, you will have more misses than hits (especially learning this risky play) and you will feel the impact of brokerage fees.

The only benefit I can think of is:

1) No model required to pay down the cost of the shares but see downside no 2)! Ie: Leverage

The biggest assumption running here is everything goes well between your purchase and the trade of your stock.

To end, again I do not endorse this move and I did so with MEGB because a) it was a stock I was willing to hold for long term and b) decided to try this for this blog's research. In the long run, brokerage fees will kill you.

If there are any contra traders reading this, please share any tips or correct me if I have made a mistake somewhere.

While researching for this post, I came across this link:

http://guanyu9.blogspot.com/2010/03/brokers-fight-for-right-to-contra-trade.html - read the comments - contra trading takes up 50% of the trading volume in Singapore and your comment practice among brokers apparently.

Full Disclosure : Joe does own shares in MEGB and will not trade for the next 3 days in MEGB.