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Advantages and Disadvantages of Stock Options Trading.

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This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

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This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

 

What i don't like about options is that are a decaying asset, the time value of the price gradually diminishes as the option approaches expiration, at which time it becomes zero.

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I would rather say option comes with a high risk and return profile. In simple words, the person who shorts the options takes the maximum risk and his profit is limited compared to the Long party in option with a risk-return profile of limited loss and unlimited gain.

 

Apart from this, the worst part in option is it's a zero sum money. It means that it's not creating any wealth in the market. It's simply a loss to one party compared to profit to the other one.

 

 

This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

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One other advantage of options trading is hedging. Options can be used as a hedge in your stock portfolio.

 

So here is a review of advantages and disadvantages of options trading.

Advantages:

Leverage.

Hedging.

 

Disadvantages:

Decaying asset.

High risk and return profile.

Zero sum money.

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One other advantage of options trading is hedging. Options can be used as a hedge in your stock portfolio.

 

So here is a review of advantages and disadvantages of options trading.

Advantages:

Leverage.

Hedging.

 

Disadvantages:

Decaying asset.

High risk and return profile.

Zero sum money.

 

Here in lies the great/confusing part of options. what is one persons advantage may be the others disadvantage.

 

Add

Advantages:

Leverage - requires good risk controls

Hedging

Decaying asset - when you are short

Zero sum - if you are constantly winning.

various strategies can be used across months and strikes.

can be used as part of a portfolio hedging strategy

Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)

Limited Downside - if long options

Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

Excessive leverage when risk controls are poor

Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge

Decaying asset - when you are long

zero sum - if you are constantly loosing and have no way of offsetting this

various strategies can be used across months and strikes -dangerous if you dont understand what you are doing

You might not have enough capital/assets to effectively implement a portfolio type strategy

Unlimited downside - if short options, (subject to expiry, and if put or call)

Limited Downside - if short options

 

Bascially - there is a lot options can offer, and there are a lot of advantages and disadvatanges and these differ greatly on if the options used are long, short, puts, calls, naked or covered.......you cannot be general with them.

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Thank you for your reply SIUYA, you are right, most of the times the advantages of options for some traders are disadvantages for some other traders and you are right that you can't be general with options. Your post was very helpful. So here is how our list looks like now:

Advantages:

Leverage - requires good risk controls

Hedging

Decaying asset - when you are short

Zero sum - if you are constantly winning.

Various strategies can be used across months and strikes.

Can be used as part of a portfolio hedging strategy

Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)

Limited Downside - if long options

Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

Excessive leverage when risk controls are poor

Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge

Decaying asset - when you are long

Zero sum - if you are constantly loosing and have no way of offsetting this

Various strategies can be used across months and strikes -dangerous if you dont understand what you are doing

You might not have enough capital/assets to effectively implement a portfolio type strategy

Unlimited downside - if short options, (subject to expiry, and if put or call)

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This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

 

Trading in binary options has increased substantially in recent years. In an earlier era, binary options trading had to be done through a specialized broker who charged high fees for the service. Today, people can visit a binary trade website and process the transaction themselves, making it both simpler and cheaper to trade binary options for fun and profit.

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Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

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Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

 

Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

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Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

 

 

Let me explain you in simple words, Suppose you have bought the Apple's one share 10 years ago at $10 and you sold the same after 5 years down the line at $20. You made a profit and its natural that somebody has bought the same from you at $20 (5 years ago). Now the current market price is $30, then he can sell the same and can make a profit. In this sense wealth is created in stock market, not in Derivative market but it depends upon the company's performance and how much income they are generating and their growth prospects.

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Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

 

stocks are generally not thought of as a zero sum game. The main reasons being that stocks have a limited number of shares issued at any one time, they usually represent a claim over some assets or cash flow (eg; supermarket, banks profits). They can actually generate wealth.

Futures and options on the other hand merely require a buyer for every seller and these are viewed as a zero sum game......much like insurance.

 

see Zero-Sum Game Definition | Investopedia

see wikipedia for more info....

eg"Many economic situations are not zero-sum, since valuable goods and services can be created, destroyed, or badly allocated in a number of ways, and any of these will create a net gain or loss of utility to numerous stakeholders. Specifically, all trade is by definition positive sum, because when two parties agree to an exchange each party must consider the goods it is receiving to be more valuable than the goods it is delivering. In fact, all economic exchanges must benefit both parties to the point that each party can overcome its transaction costs, (or the transaction would simply not take place).

"

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Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

 

This is fundamentally FALSE. The stock market is a market. The reason why prices go up on any stock is because buyers are willing to pay higher prices. Simple as that. Someone has to sell the stock to a buyer. So if a stock price has gone up for the last 25 years it is only because buyers chose to buy higher each year. Why would buyers collectively do this? For many reasons. It could be because they think that the company is undervalued. Or they perceive that the company will create or develop a new idea or technology. Companies simply do not reward you for staying with a company for many years through the payout of an increase in what you paid for the stock. No they reward you with dividends. Other buyers reward you not companies. A company is only worth what someone will pay for it.

 

The price of a stock is not directly tied to the value of the company either. It could be but only if buyers collectively use that. I would like to point out that at the peak of the last financial crisis there were many banks that suffered a loss on their stock price. The reason for it was the fact that they were banks and a majority of banks had problems. The entire financial sector suffered regardless if the company was or ever was involved with any sort of mortgage loans. This is similar to the housing market. If you have the nicest house on the street and a few houses on your block or in your area are run down then it diminishes the value of your house.

 

Here is an example of your fallacy. If you would of bought 10 contracts of ES a few years ago when it was at 700 and then sold it today at 1517 you would be up. So based on your example the ES generated wealth. And this is based on a supposed index of more then 1 company. Given the example so far the ES seems to be a better form of generating wealth. Also you can short sell stock. This in effect is similar to a futures trade in that you are not required to "own" something before selling it.

Edited by Colonel B

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Let me explain you in simple words, Suppose you have bought the Apple's one share 10 years ago at $10 and you sold the same after 5 years down the line at $20. You made a profit and its natural that somebody has bought the same from you at $20 (5 years ago). Now the current market price is $30, then he can sell the same and can make a profit. In this sense wealth is created in stock market, not in Derivative market but it depends upon the company's performance and how much income they are generating and their growth prospects.

'Hi Larry, I understand your point. However I am making much more broader view based on the fact that no company grows forever, every company will go up and down. Lets stay in that respect, stock follows the pattern. No stock will go up forever, it will eventually go down. There are winners on the upward motion and losers in the downward motion. In that sense it is also zero sum. There is really not a wealth created here. No coin is being printed, no tangible product is being created when stock price goes up. It is just price is going up like a product. Just like a gas price. You cant say the wealth is being created when the price goes up. Sellers of gas gain and take advantage by of higher gas with higher revenue where a consumer suffer by paying more. and vice versa when the gas price falls down.

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'Hi Larry, I understand your point. However I am making much more broader view based on the fact that no company grows forever, every company will go up and down. Lets stay in that respect, stock follows the pattern. No stock will go up forever, it will eventually go down. There are winners on the upward motion and losers in the downward motion. In that sense it is also zero sum. There is really not a wealth created here. No coin is being printed, no tangible product is being created when stock price goes up. It is just price is going up like a product. Just like a gas price. You cant say the wealth is being created when the price goes up. Sellers of gas gain and take advantage by of higher gas with higher revenue where a consumer suffer by paying more. and vice versa when the gas price falls down.

 

I guess you have interpreted wrong my friend. I made the comparison between stocks and Derivative market.

 

Before answering the question, "Do stock market really create wealth" ?

 

Let us first understand the nature of stock markets. A stock market is a place where people can buy and sell their shares in companies. The price at which they buy and sell is determined by demand and supply of shares at that point in time. In other words when marginal demand for shares is plentiful relative to marginal supply, prices will rise and vice versa. The key to stock market prices is marginal demand and supply. People who buy and hold shares for the long term ensure that marginal supply does not increase thereby keeping a floor under prices until they decide to sell. As long as buy-and-holders keep buying, we can safely assume a rising floor for prices. Once they decide to sell, the floor collapses.

 

Company profits have a role in influencing stock market prices i.e. in attracting people to buy the company’s shares. A company with a long track record of rising profits attracts a large number of buy-and-holders thereby reducing the stock’s marginal supply while simultaneously increasing marginal demand which effectively raises the price floor. Profits may be real or created by accounting manipulations. Both have the same effect on stock market prices.

 

Unfortunately, people forget that a track record of rising profits (either real or illusory) is unsustainable and has to break at some point in time. Profit disappointments cause the price floor to break. Once broken, it is near impossible to stop from going down significantly at a pace determined by the buy-and-holders. Real profits erode slowly while accounting illusions disappear rapidly. Hence the decline of really profitable companies is slow whilst it is rapid for those companies whose profits are illusory.

 

Wealth is measured as an increase in nominal net worth. As long as stock prices rise, your wealth increases while it decreases when stock prices fall. It is clear that you have exit at the right time for your wealth to sustainable increase. Exiting at the right time requires a lot of ability and luck.

 

There are investors who have held stocks for decades and have generated tremendous wealth just by holding on to those stocks. The key reason for this growth in stock market wealth is the massive increase in money supply. As long as money in the system remains constant, price rise in one stock is usually accompanied by fall in another as money to buy can be generated only by selling. This would ensure that the market cap of the stock market remains constant. But if money in the system increases, buying can be done without selling thereby raising the overall market cap. Unfortunately, we have lived in an inflationary world for so long that people have come to accept it as a natural reality rather than a political choice. This has lead to the belief that stock markets always rise in the long run and equities generate tremendous wealth.

 

But on the other hand, Derivatives never generate wealth. I hope this is clear.

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I think one of the biggest advantages of trading options is that they give you the flexibility and ability to create complex positions that would not be possible if you only traded the underlying. Even a short vertical spread gives you some pretty cool things: it can make money if price moves, doesn't move, or only moves against you a little bit.

 

You can also construct positions that move in your favor more as they move in your favor and go against you less as they go against you. Both seem pretty desirable.

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I think one of the biggest advantages of trading options is that they give you the flexibility and ability to create complex positions that would not be possible if you only traded the underlying. Even a short vertical spread gives you some pretty cool things: it can make money if price moves, doesn't move, or only moves against you a little bit.

 

You can also construct positions that move in your favor more as they move in your favor and go against you less as they go against you. Both seem pretty desirable.

 

Thank you for your reply ThetaTrend, your post was very helpful. So here is how our list looks like now:

 

Advantages:

  • Leverage - requires good risk controls
  • Hedging
  • Decaying asset - when you are short
  • Zero sum - if you are constantly winning.
  • Various strategies can be used across months and strikes.
  • Can be used as part of a portfolio hedging strategy
  • Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)
  • Limited Downside - if long options
  • Flexibility and ability to create complex positions that would not be possible if you only traded the underlying
  • Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

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Thank you for your reply ThetaTrend, your post was very helpful. So here is how our list looks like now:

 

Advantages:

  • Leverage - requires good risk controls
  • Hedging
  • Decaying asset - when you are short
  • Zero sum - if you are constantly winning.
  • Various strategies can be used across months and strikes.
  • Can be used as part of a portfolio hedging strategy
  • Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)
  • Limited Downside - if long options
  • Flexibility and ability to create complex positions that would not be possible if you only traded the underlying
  • Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

 

Adding to your point, Options are really useful for hedging. If the trader has the knowledge of option Greeks (mainly delta and gamma) then they can use the same and easily manage their risk and return profile.

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Options basically created for hedging and soon speculators jumbed in to make some extra profits in the new market. Greeks are useful tools in the hedging procedure.

 

We all know that options were earlier introduced for Hedging but due to its payoff profile, it attracts traders to come. Options is equally traded by arbitrageurs as well.

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I believe that today most of the participants in the options markets are speculators, hedgers are the institutionals investors and hedge funds.

 

Don't forget Arbitrageurs, they are also one of the big market participants. They play in big volumes, but frequency is less.

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Wth options you can take a position with very low capital requirements. A trader can do a lot in the options market with $1,000 but not so much with $1,000 in the stock market.

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Please note that times displayed based on local time zone and are from time of writing this report. Click HERE to access the full HotForex Economic calendar. Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding on how markets work. Click HERE to register for FREE! Click HERE to READ more Market news. Stuart Cowell Head Market Analyst HotForex Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
    • Date : 2nd December 2021. Market Update – December 2- Sentiment swings on Omicron news. Powell reiterates Hawkishness, First case of Omicron confirmed in US – Stocks tank again under key technical levels, Yields slip again, USD mixed. Erdogan sacks Fin Min – TRY new all-time lows, Apple iPhone 13 demand weakens, GSK anti-viral drug remains active vs. Omicron   USD (USDIndex 96.08) rotates through 96.00 due to lack of firm data regarding Omicron, markets reamin on edge. Stocks fell significantly with USA100 down over -1.83% USA500 -1.18% (-54pts) 4513 (opened the day +1.1%) and broke 50-day MA first time since October 14 & USA30 off 461 pts and under 200-day MA first time since July 13 2020. US Yields 10-year rates were down over 7 bps to 1.40% before recovering to 1.434% now. Asian Markets – Asian markets have traded mixed. Topix and Nikkei are down -0.5% and -0.7% respectively. The ASX lost -0.1%, but Hang Seng and CSI 300 are up 0.2% and 0.3%. Shenzen and Shanghai Comp are slightly lower though as officials seem eager to close a loophole used by tech firms to list abroad. USOil – continues under pressure, down to $64.50 yesterday – recovered to test $66.35 today – awaiting OPEC+ meeting later. Gold Up day yesterday but remains pressured testing $1775 now FX markets – Yen rallied USDJPY dipped to 112.70, back to 113.31 now, EURUSD now 1.1312 & Cable pressured 1.3192 low yesterday – 1.3275 now. European Open – The 10-year Bund future is up 30 ticks, outperforming versus Treasuries, which remain pressured by the hawkish turn at the Fed. The 10-year Treasury yield has lifted 3.0 bp overnight, but at 1.43% remains far below the levels seen ahead of the Omicron scare, which the WHO seemed to try and play down somewhat. DAX and FTSE 100 down -1.1% and -0.9% respectively in catch up trade with the slide on Wall Street yesterday, while US futures have found a footing and are posting gains of around 0.6-0.8%. Today – EZ Unemployment Rate, US Weekly Claims, Fed’s Bostic, Quarles, Daly, ECB’s Panetta, JMMC/OPEC+ meetings. Biggest FX Mover @ (07:30 GMT) CADJPY (+0.77%) Risk-sensitive currencies remain volatile, from a slide to 87.85 yesterday, today a rally to 88.60. Currently MAs aligned higher, MACD signal line & histogram under 0 but rising, RSI 56 & rising, OB. H1 ATR 0.188, Daily 0.98. Always trade with strict risk management. Your capital is the single most important aspect of your trading business. Please note that times displayed based on local time zone and are from time of writing this report. Click HERE to access the full HotForex Economic calendar. Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding on how markets work. Click HERE to register for FREE! Click HERE to READ more Market news. Stuart Cowell Head Market Analyst HotForex Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
    • You should never give in to the rumors as it could lead you to bankruptcy if it isn't true.
    • Yeah, and you should never stop learning. If you wish to survive in the Forex Market, the only way to do it is by learning all the time.
    • Date : 1st December 2021. Market Update – December 1 – Taper gets a boost & Transitory gets “retired”. Powell “retires” Transitory in light of Omicron & surprisingly suggests faster taper – Stocks tank, Dollar& Yields rise on faster tightening expectations.   USD (USDIndex 95.90) back down from leap to 96.60 on Powell testimony. Saw fresh wave of risk aversion as Treasuries sold off, yields spiked (particularly the 2yr) , Stocks fell significantly with USA100 down over -2.4% (APPL bucked the trend +3.16%) USA500 -1.90% (-88pts) 4567 & USA30 off 652 pts or -1.86%. Consumer confidence saw a slump in the headline, and a rise to a 13-year high in the inflation component. The Chicago PMI fell to 61.8. Home prices increased to fresh record peaks. US Yields 10-year rates were down over 7 bps to 1.41% before closing at 1.443% before recovring to 1.468% now. Asian Markets – Equities – Topix and Nikkei are currently up 0.4%, the Hang Seng bounced 1.1% and the CSI 300 is up 0.1%. The ASX, which outperformed yesterday, dropped back -0.3%. Data over night – Japan’s manufacturing PMI came in stronger than expected and while China’s private PMI reading signalled stagnation at 49.9, that was compensated somewhat by the stronger than expected official manufacturing PMI released yesterday. AUD GDP was not as bad as expected -1.9% vs -2.7% & 0.7% last time. USOil – continues under pressure, down to $64.08 (14-week lows) yesterday – recovered to test $68.00 today – expectations continue to grow that OPEC+, will put on hold plans to add 400,000 barrels per day (bpd) of supply in January at their meeting tomorrow. Gold finally some intra-day volatility – Powell surprise spiked to $1808 – before testing $1770 with a couple of hours, back to $1788 now. FX markets – Yen rallied USDJPY dipped to 112.50, back to 113.40 now, EURUSD now 1.1326 & Cable steadied to 1.3300-1.3330. European Open – December 10-yr Bund future down -11 ticks at 172.26, slightly outperforming versus Treasury futures. Central bankers may be getting more nervous about inflation outlook, but Omicron clearly is clouding over growth outlook & in Europe at least that will boost the arguments of the cautious camp at the central banks. US yields remain firmly below the levels seen before the new virus variant hit the headlines & sentiment is likely to remain jittery, even if stocks are set to back up from yesterday’s lows, with DAX & FTSE 100 future posting gains of 0.9% and 0.7% respectively & a 1.4% jump in the NASDAQ leading US futures higher. Data releases today kicked off with a big miss for German Retail sales (-0.3% vs 1.0%), higher UK house prices & firmer CPI from CHF. Today – PMIs (EZ & UK),US Markit Final Manufacturing PMIs, US ADP and ISM Manufacturing PMI, JTC and OPEC meetings, BoE’s Bailey and Fed’s Powell & Yellen testify. Biggest FX Mover @ (07:30 GMT) NZDJPY (+0.60%) Risk-sensitive currencies remain volatile, from a slide to 76.65 yesterday, today a rally to 77.80. Currently MAs aligned higher, MACD signal line & histogram over 0 and rising, RSI dipping from 70.00 at 58, Stochastic remain OB. H1 ATR 0.172, Daily 0.84. Always trade with strict risk management. Your capital is the single most important aspect of your trading business. Please note that times displayed based on local time zone and are from time of writing this report. Click HERE to access the full HotForex Economic calendar. Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding on how markets work. Click HERE to register for FREE! Click HERE to READ more Market news. Stuart Cowell Head Market Analyst HotForex Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
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