This article follows the introduction of new comers to the CFD trading (with a focus on the possibility to trade online) by answering the most common 12 questions on the topic.
According to the definition the contract for difference (also known as CFD) represents a contract between two different market players, one is a buyer and one is a seller, that states that the seller pays the buyer the difference between the t0 value of the asset and the future value at the contract time. In the scenario where the difference has a negative value, the buyer pays to the seller). In common practice this derivatives type of instrument is used for speculative trades.
The history of the CFD’s comes from the early 1990s (primarily used by hedge funds to cover up positions on the London Stock Exchange, the big advantage was that no tax ware paid) but the wide availability came in the late 2000s when retail traders discovered the potential behind this derivative financial instrument.
1) What Is CFD trading ?
CFD trading gives you the opportunity to trade market moves (in most cases with the help of leverage) on all scenarios, if you open a short position your prediction is for a drop of the price, on the other hand if you open a long position you estimate that the price will rise. For each point (traders call them pips) the price moves up you win or lose due to the difference between the initial price and the real time price.
2) Basic Example Of a Trade ?
Let’s say that you what to trade The Coca-Cola Company (NYSE: KO) shares, and based on your prediction the price will go up, that means that you place a buy order (long position) for 2,000 CFD’s at the price of 40$ :
In the price rises to 45$ and you decide to sell at that point your profit is (45$-40$) x 2,000 = 10,000$
If the price goes down to 37.5$ and you make a smart move and limit your loss, your final down slip will be: (37.5$-40$) x 2,000 = -5000$
3) How Can I Trade ?
The simplest way to trade is by using an online broker that will provide you with access to markets by a trading platform or software. Usually you need only one platform and account to access global markets (with some small exceptions).
4) What Assets Are Available For Trading ?
Due to the market expansion and wide spread along retail traders, the market offer has gone up, in these days you can trade almost everything starting from stocks, bonds and finishing with currency, indices and commodities.
5) A Lot of People Talk About Leverage. What is Leverage ?
Leverage is used to increase potential of an investment by increasing the value of margin (margin represents the borrowed capital, this usually comes from your broker).
6) Do CFD’s Provide Higher Leverage ?
Yes! In comparison with traditional trading instruments. The average market rate starts at about 2% as margin requirement, but this varies a lot form asset to asset, for some it goes as much as 30%.
7) What Is The Biggest Advantage ?
Some financial markets apply rules for shorting stocks, some that imply even borrowing the stock before taking action or margin requirements, in the case of CFD’s there are no rules for shorting or long positions. Another advantage is the fact that since there no actual owning of that certain asset, borrowing of shorting costs do not exist.
8) What is the Biggest Disadvantage ?
Not all contract for difference industries are regulated by official financial regulators (usually from the state), and this can cause a lot of suspicion over the service providers.
Tip #1 – CFD Trading Strategies
One of the most common cfd trading strategy is called forex scalping and it offers traders the option to profit from small market moves by opening and closing positions fast after gaining the first pips.
Tip #2 – Day Trading Requirements
Most of the markets ask from traders minimum amounts of capital in order to day trade, or are most likely to post limits on the amount of trades done in a day from an account. By entering a CFD market the regulations are not applied, traders have the option to place unlimited amounts of trades and minimum account amounts start from 100$ at respectable market players.
Although cfd trading looks like a very simple job, it is NOT and many beginners fall in the rush trap ending up losing money. The most common causes and lack of knowledge regarding leverage, margin and money management. Before opening any position be sure to make a checklist of actions and document all possible documentation available.