CFDs Trading

Are you searching for an alternative option to stocks trading? Then the perfect answer is CFD trading. These well-known financial instruments are crucial components in the portfolio of any trader. For beginners who have just embarked on the journey of trading, the concept of CFD may be difficult to understand. A trader must have a full grasp of CFDs’ advantages and disadvantages before he thinks of investing in these financial instruments.

A brief overview

CFD is the abbreviated form for a contract for difference. In CFD trading, you will not be required to buy or sell any of the underlying assets. Though this kind of trading imitates the share trading environment significantly, this is where the point of difference lies. In a contract for difference, you do not own the underlying asset. In the case of share trading, the shareholder owns shares of stock of companies.

How do CFDs work?

When dealing with these derivative products, you are engaged in the speculation of financial instruments, for instance, Forex, commodities, and shares. The key concepts that play a dominating role in CFD trading are price quote and spread, deal sizes, expiry date, and profit or loss.

  • Price quotes and spread

    Two prices are quoted in CFD markets: the buy price and the selling price. When buying, a trader is required to pay the asking price and when selling, a trader is required to accept the bid price. When you are expecting a rise in price, you buy a certain number of CFD units, and when you are expecting the price to fall, you sell those CFD units. The difference between the bid and ask price is referred to as the spread.

  • Deal size

    One of the important terms in Forex is a lot, which represents the trade size. Knowing the trade volume is important because it can impact the trading strategies and the levels of profit. The chances of encountering big profits or big losses increase when dealing with a bigger lot, which means exposure to greater risks. On the other hand, a smaller lot is suitable for beginner traders who are comfortable dealing in smaller sizes and want limited risk exposure.

  • Expiry date

    Unlike options, most CFDs do not have any expiry date. The exception is a future based CFD. A CFD position may be closed manually by performing the opposite action to the one that you did initially. For example, a buy position of 1000 silver contracts, for example, would be closed by selling 1000 silver contracts. You may minimize your losses by setting stipulations such as stop-loss orders. Overnight funding charges are levied for maintaining position past the cut off time.

  • Calculation of profit or loss

    Profit or loss is calculated by multiplying the deal size with each contract value. The figure computed is then multiplied with the difference between the closing price and opening price of the contract. When the particular instrument’s price for every point shifts to your favor, you will make a profit. When the reverse happens, you will end up with a loss.

Pros and Cons of CFD Trading

CFD trading is a type of derivatives trading where you are dealing with prices that are obtained from the underlying market instead of the underlying market itself.  A trader should be conversant about the benefits and dangers associated with these financial instruments.

Pros/Advantages of CFD Trading

  • Free from stamp duty
    The trading of CFDs does not have stamp duty because it does not involve buying stock or marketable securities. You will come across stamp duty while trading equities in some jurisdictions. As an investor, you can use the margin to your advantage to create a greater economic exposure than the cash flow in reality.
  • Leverage aspect
    In traditional financial instruments, traders are required to make a trading commitment of cent percent of their capital for opening a position. In contrast, for opening a position in CFD trading, the margin requirement is five percent. As a result, traders have an opportunity to enhance their potential profitability by investing a lower amount of capital for opening a position. The factors which play a vital role in determining the amount you will need to deposit are the position size and margin factor. Of course, this paves the way for larger potential losses. Some of the risks can be significantly reduced through negative balance protection.
  • Market Fluctuation
    CFD trading provides an opportunity for the traders to earn irrespective of the prevailing market conditions. As a trader, you can open positions and take advantage of both bear and bull markets. A wide array of investing opportunities exists in the market, and a trader enjoys flexibility regarding when and how to open positions. Start trading on the buy price when you have the feeling that the market may rise. On the contrary, start trading on the selling price if you nurture the feeling that the market may be going down.
  • A vast range of options
    You will gain access to seventeen thousand markets, and you can use contracts for differences in trading in a wide range of markets. They may be in the form of commodities, Forex, shares, indices, crypto currencies, and other options. For this purpose, you will not be required to utilize multiple platforms. Whenever necessary, you can use one login for trading from your phone, computer, or tablet. The markets are located in various parts of the world and in different time zones. Investors may take resort to post-market trading even after the market closure. Depending upon the company’s announcements, the opening price may vary significantly from the out-of-hours price.
  • Absence of expiry date
    Over time, in comparison to other major financial instruments, there is no depreciation of CFD values. They do not have expiry dates. They have lesser restrictions regarding closing a position compared to other kinds of investments, such as futures. You will need to exercise a patient attitude while dealing with long positions. As a day trader, you may not be able to avail of any significant benefit, but if you are ready with a long-term investment mindset, you will be able to derive many benefits. See the market through its various cycles and then finally make a selling decision at the right time.

Cons of CFD trading

  • Downside of leverage
    The concept of leverage may prove to be a boon in most cases. However, if not approached with a cautious attitude, leverage may cause disruption to your trading capital. Just as the movement of a few percentage points in the favorable direction may leave a tidy amount of return in your hands in the same way movement in the opposite direction may prove to be extremely detrimental. The target is to attain the right balance of leverage, so that movement in an unfavorable direction does not have a negative impact on your trading capital. The trick is to avoid unnecessary risks to the extent possible. A steady yet gradual approach will help in the dramatic reduction of the leverage impact, especially when dealing with wrong positions. This will ultimately minimize the risk element involved in leveraged trading.
  • Tend to overtrade
    With the assistance of CFDs, the traders can gain access to the markets even by putting in lower investment. Capital commitment is much lower in each trade. So the traders may slip into the habit of overtrading. This situation may become dangerous because your portfolio may become overexposed to the markets at any given point in time. In such situations, your portfolio may not be sufficient for covering the total losses in the portfolio. Loss of a few percentage points may spell financial disaster for even those individuals who are treading recklessly.

How to trade CFDs?

The world of CFDs is undoubtedly exciting but being knowledgeable helps to survive in this unpredictable market.

  • Picking a market

    The first thing you need to decide is the market where you want to conduct trading operations. For purposes of trading, you can draw inspiration from the various research portals.

  • Buy or sell

    If you feel there will be an increase in price, you should click on the buy option. Click on the sell option if you feel the market is going to fall in value.

  • Selection of trade size

    You have to decide how many CFDs you want to be involved with by defining the position size. This gives you a scope to capitalize on the fluctuations in the market.

  • Stop-loss command

    Curtail your risks by opting for stop-loss order in CFD trading. Place a stop-loss request for activating an order if the price in the market goes beyond a threshold.

  • Monitoring the trade

    After placing your trade, start monitoring the profit or loss scenario. Advanced tools will help you to monitor in real-time. Exit trade by using the close trade button.

The deposit that you are required to put down for placing a trade and maintaining a position is denoted as margin. Adequate net equity should be present in your account when you place a trade to cover margin requirements, commission, and other relevant charges.

  • Traders all across the world utilize CFD for its leverage feature. With this investment technique, you will need a smaller capital for gaining exposure to the markets.
  • In CFDs, there are two kinds of margin – deposit margin and maintenance margin. For opening a position, a deposit margin is essential. For maintenance of open positions keeping a certain amount of funds is necessary. If the position starts incurring losses, then the trader may get a margin call from the broker where one may need to put in additional funds.
  • Strategic placing of trades so that the profit or loss in one position can be counterbalanced with the modifications in the other asset’s value is referred to as hedging.

For a newbie, CFD trading may seem complicated in the initial phase. However, if you take a look at the following example, you will find that it is not so complex.

  • In this example, the XYZ company is engaged at a sell/buy price of 1,499/1,500p. Tier 1 margin rate is set at 5%, which indicates that you will have to deposit 5% as a deposit margin.
  • If you are interested in buying 1000 CFD units because of the likelihood of rising prices, then your position margin will amount to £750. The figure is computed as {5% * (1000 units *1500p buy price)}.
  • The movement of price against you will cause you to lose money in excess of the margin position of £750. Just as you had predicted, within the next hour, the price has shot up to a sell/buy price of 1,525/1,526.
  • Now you have decided to close the position based on the new sell price that is by selling at 1625. In your favor, the movement is by 25 points (1525-1500). The gross profit is calculated as £250, which is the price shifting product and position size.
  • Commission charges will be levied in the following way: while buying the commission will be 1,000 (units) x 1,500 pence (price) x 0.10% = £15.00 and while selling the commission will be 1,000 (units) x 1,525 pence (price) x 0.10% = £15.25. Total commission will work out to be £15.00 + £15.25 = £30.25.
  • Your net profit will be the figure you arrive at after deduction of total commissions from the gross profit. In this case, it will be £250 – £30.25 = £219.75.

Along the entire journey as a trader, the platform you decide to pick will act as the base of all your investment ventures. Proper selection of this crucial aspect is necessary because user-friendly platforms will assist in the easy and smoother execution of trades. Ideally, your choice of a trading platform should have charts, real-time quotes, prices, and an easy to navigate interface. Search for a platform that offers you the best of features and caters to your specific needs and is known for its reliability in the industry.

The trading costs involve a commission and the spread. The difference between the bid and offer price is referred to as the spread. Whenever there are immediate buying and selling of CFDs, the spread is calculated as the difference between your receipt and payment. You are going to receive interest whenever you deal with share-based CFDs. No commission is generally involved when you are dealing with Forex pairs. In this case, it is the bid-offer spread, which is only taken into account.

Leave a Reply

Your email address will not be published. Required fields are marked *