Underlying assets in CFD trading. The ultimate guide

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CFD Trading 101: The Ultimate Guide to the World of CFDs

Table of Contents

Learning about investments and different investment strategies often feels like reading Hindi when your native language is Swedish.

Simply, CFD stands for Contract for Difference. Hopefully, that clears some things up. No?

Don’t worry, you’re not alone. There’s a great deal to know about CFDs and how to trade them.

This guide should help you understand some of the basics of CFD trading and how to get started. Any new investment strategy you learn about will require research, discipline, and practice.

Once you read this guide, you may be on your way to diversifying your profile. Good luck and have a go.

What’s a Contract for Difference?

A Contract for Difference, or CFD, offers traders the opportunity to profit from changes in value without owning the asset. The trader must make a contract with a broker.

The CFD trader uses their knowledge of the market to predict whether the value of the asset will increase or decrease.

CFD trading works with a variety of different assets. These include stocks, commodities, and indices.

Think of it like making a bet with the stockbroker. If your prediction is correct, the seller must pay the difference between the initial buying price and the new value. If you’re wrong, you must pay the difference.

Each trade is leveraged, so you don’t need a lot of capital to start out. You’ll put down a small deposit with the broker with your particular speculation about price movement.

The Spread

The CFD spread is the difference between the buying price and the selling price. When you trade CFDs, you need to be aware of these two prices.

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The selling price is known as the bid. The buying price is known as the offer. The offer will always be the greater of the two prices.

When you trade CFDs, your aim is to maximize your profits off these spreads.

When you place a trade, you make a bet the cost of the underlying asset will move in a particular direction. That is, the value of the asset will rise or fall.

The value of the underlying asset will often be between the two price points. When the value moves beyond the cost of the spread in your favor, the trade will make you a profit.

If the asset fails to do so, you’ll lose.

Why Choose CFD Trading

There are several different reasons to choose CFD trading over other types of trading. When you trade CFDs you’ll face higher leverage than traditional trading.

This can be either good or bad, depending on how the individual trade goes.

This allows you to put less money toward a single trade than traditional trades. Higher leverage allows greater returns. However, it can also lead to greater losses.

Access to Global Markets

Many brokers will allow you to trade on major markets around the globe. This allows you to greater diversify your portfolio.

You may have access to the markets around the clock.

Trading Opportunities

With CFD trading, you can trade various different types of assets. Many stockbrokers offer CFDs for stocks, indices, currency, treasury, sector, and commodities.

Smaller or No Fees

Stockbrokers make money when traders pay the difference on a spread. Most don’t charge any commission or fees because of this.

However, they still offer many of the same services as traditional stockbrokers. They often offer stops, limits, and contingent orders.

A contingent order is an order to authorize simultaneous transactions. They can be useful in defining stop-loss points for a trade. Depending on the broker, you may need to pay a fee for these services.

When you trade CFDs, you buy into a contract with a stockbroker. You must pay the asking price and sell at the bid price.

Requirements to Day Trade

Many different markets place certain requirements to make day trades. You must usually have a certain amount of free capital to day trade or place limits on the number of trades you can make during a period.

The CFD market doesn’t place any of these restrictions. All traders can day trade if they wish.

You will, however, need to make an opening deposit. This deposit can range from $1,000 to $5,000.

Downsides of CFDs

All is not peachy in the realm of CFDs. Such is the nature of life. Trading CFDs does come with its share of drawbacks.

If you’re not careful, you could fall victim to certain pitfalls. For example, you may be stuck paying the difference on spreads.

This can limit your profitability on each trade you make in the CFD market. This is because the spread slightly decreases winning trades compared to the value of the underlying asset.

You may see greater losses for the same reason.

In addition, the market has weak regulations. Searching for a reputable stockbroker can present a bit of a challenge.

Stockbroker credibility isn’t based on government standing or liquidity of assets. Instead, credibility is based on lifespan, reputation, and financial position.

Good for Beginners?

Experienced traders often utilize strategies in the CFD market. It can get quite complex and may not be too friendly to beginners.

However, anyone can successfully trade CFDs with enough market knowledge and research. You should aim to find out more about CFD trading and how it compares to traditional trading.

The CFD market can present high risks for traders. You need to be aware of all the risks before you start.

Get Started in the CFD Market

If you believe CFD trading may be right for you, you can easily get started. You’ll need to find a stockbroker or platform to allow you to do so.

This itself can be a challenging task. If you’re just starting out, make sure you can back up your trades with market knowledge and planning. You should never make investments larger than what you can afford to lose.

Hopefully, this guide has cleared things up a bit. If you’d like to learn more about finance and living better, visit here.

An Introduction To CFDs

The contract for difference (CFD) offers European traders and investors an opportunity to profit from price movement without owning the underlying asset. It’s a relatively simple security calculated by the asset’s movement between trade entry and exit, computing only the price change without consideration of the asset’s underlying value.   This is accomplished through a contract between client and broker, and does not utilize any stock, forex, commodity or futures exchange. Trading CFDs offer several major advantages that have increased the instruments’ enormous popularity in the past decade.

How a CFD Works

If a stock has an ask price of $25.26 and the trader buys 100 shares, the cost of the transaction is $2,526 plus commission and fees. This trade requires at least $1,263 in free cash at a traditional broker in a 50% margin account, while a CFD broker formerly required just a 5% margin, or $126.30. A CFD trade will show a loss equal to the size of the spread at the time of the transaction so, if the spread is 5 cents, the stock needs to gain 5 cents for the position to hit the breakeven price. You’ll see a 5-cent gain if you owned the stock outright but would have paid a commission and incurred a larger capital outlay.

If the stock rallies to a bid price of $25.76 in a traditional broker account, it can be sold for a $50 gain or $50/$1263 = 3.95% profit. However, when the national exchange reaches this price, the CFD bid price may only be $25.74. The CFD profit will be lower because the trader must exit at the bid price and the spread is larger than on the regular market. In this example, the CFD trader earns an estimated $48 or $48/$126.30 = 38% return on investment. The CFD broker may also require the trader to buy at a higher initial price, $25.28 for example. Even so, the $46 to $48 earned on the CFD trade denotes a net profit, while the $50 profit from owning the stock outright doesn’t include commissions or other fees, putting more money in the CFD trader’s pocket.

Trading CFD Made Easy! the Ultimate Beginners Guide to CFDS

Robert Clough

Interested in trading CFDs?

The contract for differences, otherwise known as CFDs, are a favorite investment option for private investors, like you. They entered the market of retail financing in 1998. That was ten years after investors recognized they could replace traditional share markets.

At the time, the high stamp duties created by the UK Government contributed to CFD’s rapid growth. Maintaining short-term positions in the traditional market was a problem. It led investors to throw their money behind CFDs.

Unlike other strategies, CFDs are excellent for short-term positions in markets. Both then and now. When you’re ready to learn how to capitalize on this new trading strategy, grab a cup of tea, cozy in, and read on.

Defining CFDs

For those of you who’ve never heard of these types of trades, we’ll give you a brief introduction to CFDs.В

In essence, contract for differences are a way for traders to profit from price movements. The best part? Traders don’t actually have to own any of the underlying assets.

The difference between the price as you enter a trade and the price as you exit a trade determines your profit or loss.

CFDs are simple securities, computed by your asset’s movement between your trade entry and exit. This calculation is performed without consideration of the asset’s underlying value.

CDFs are also leveraged. That means you gain large market exposure for a small initial deposit. Said in a different way, the return on your investment is much larger than in other, similar forms of trading.

Keep in mind that while greater leverage can magnify profits, it can also magnify losses. If prices move against you, it’s possible to close out of your position by a market call. In this case, you could also top up your funds to keep as an alternative, to keep your position open.

Note:В If you’re in the market for more than one type of investment strategy, take a few minutes to learn about short selling. It has a moderate learning curve, but it’s one of the best methods to make money fast.

Trading CFDs

If you’re trying to learn how to trade CFDs, the following steps will give you a brief overview of how it’s done:

Determine your financial instrument: What will you choose to trade on? EUR/USD? UK 100? You can use CFDs across a wide range of markets, like forex, indices, shares, commodities, or treasuries.

Decide to buy or sell: Go long (or buy) when you think prices will rise. Go short (or sell) when you think prices will decrease.

Choose a trade size: How many units would you like to trade? The value of each CFD unit varies. Its value is dependent on which instrument you’ve chosen to trade.

Manage risk:В Choose from a range of stop-loss orders. Those include “guaranteed stop-loss orders,” otherwise known as GSLOs. Sure, GSLOs come at a premium, but they’re well worth the money in some cases.

They guarantee you close out of a trade at your specified price, regardless of gapping or market volatility. If the GSLO isn’t triggered, it’s refunded in full.

Monitor position: After you place your trade, monitor your open positions, so you can follow your real-time profit or loss. That includes any take-profit or stop orders. Never forget, your losses can exceed your deposits.

Close position: If a take-profit or stop order doesn’t trigger your trade to close out, you’ll have to close out your trade manually.

Markets You Can Trade CFDs

The following are the common global markets on which you can trade CFDs, both short and long:

If you don’t see your market here, check again in the future. There’s a chance more will be included.

CFD Examples

For those of you who are new to CFD stock trading, don’t worry. This article is the “CFD for dummies” version. Let’s look at some examples.

Let’s assume for the sake of argument that Acme plc is trading at 1599/1600p. You think the price will rise, so you decide to buy 1000 share CFDs (units). Acme plc has the tier one margin rate of 5%.

That means you deposit 5% of Acme plc’s position value as position margin.

Your position margin is going to be ВЈ800 (5% margin x (1000 units x 1600p purchase price)). Don’t forget, if the price moves against you, it’s possible for you to lose more than ВЈ800.

Possible Result A of Your Trade: You predicted correctly. The price of Acme plc rises in the next hour to 1625/1626p. You sell at the new price, 1625p, and close your position.

The price moved 25 pence (1625p – 1600p = 25p) in your favor. To calculate your profit, multiply 25p by your position (aka 1000 units). It leaves you with a profit of ВЈ250.

Possible Result B of Your Trade: You predicted incorrectly. The price of Acme plc plunges over the next half hour to 1349/1250p. You’re certain it will continue dropping, and you want to bail out as soon as possible. You want to limit your losses, so you sell at 1349p. That closes your position.

Here are the calculations. The price moved 250p (1350p – 1600p = -250p) against you. To calculate your loss, multiply 250p by your position (1000 units). You come up with a loss of ВЈ2500.

Other Things to Consider

Commission costs for CFDs run at 0.10% with a ВЈ9 minimum commission charge for each trade. The costs can dramatically influence your bottom line if you’re only performing small trades.

You also need to consider holding costs. You’ll be charged a holding cost for any position you hold after 5 pm PST. This price is automatically built into the price of products with fixed expiry.

What’s next?

Trading CFDs is a relatively easy game to understand, though a difficult game to master. If your interested in learning more, try trading paper or creating a demo account. Then you can get a better feel for how the game is played without risking any actual money.

Are you curious to learn more? Then drop what you’re doing and come take a look at our list of epic finance articles.

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