Today I am going to focus on how to CFD trade. Even without asking, this comes with the question of what is CFD trading?
CFD trading provides you with an opportunity to speculate on the falling and rising in financial instruments or markets like indices, currencies, commodities, treasuries, and shares.
CFD in full means a Contract For Difference. It is a form of derivative trading where the differences between the opening and closing trade prices are not normally cash-settled.
Contracts for Difference (CFD) trading is a financial trading similar to Forex trading. CFDs have lower trading barriers to entry and one is able to trade on any online platform.
This form of trading however is quite complex to understand for many aspiring traders.
When trading on the CFD platform, you choose the instrument you intend to trade and input your order.
It works in a similar fashion like other trades where if you believe that the price of an instrument such as crude oil will rise, you definitely want to buy the crude oil CFD.
If you believe the price will drop, then you sell the instrument CFD. It is important to understand that like any other trade, wrong predictions cause you a loss of money.
Let’s continue assessing how to CFD trade as we examine how it works.
How to CFD Trade
CFD trading offers traders the advantage of trading on margin.
This means you can sell (short) if you believe that prices will decrease and buy (long) if you think that prices will increase.
CFDs are tax-efficient in countries such as the UK, to mean traders do not pay stamp duty.
One can also use CFD trades to hedge an active physical portfolio.
With the CFD trade, you don’t buy or sell the basic asset such as a physical share, currency pair or commodity.
You buy or sell a number of units for a specific instrument depending on how you think the prices will go.
CFDs are offered on a wide range and on different global markets.
For each point the price changes in your favor, you gain many times the number of CFD units you have sold and bought.
For each point the price moves against you, you incur losses.
Let’s continue assessing how to CFD trade as we examine how it works.
How CFD Trading Works
Putting aside terms like ‘underlying assets‘ and ‘contracts’, trading CFDs basically gives you the chance to make a profit if a market moves either up or down.
What you need to trade:
- First create a trading account with a CFD broker.
- Download the broker’s CFD software or platform.
- Select an asset you would like to trade.
- Decide the direction you think that asset’s price will go; up or down.
For instance if the price of gold was $1,350 each ounce, and you thought it would go up then you could open a ‘buy’ trade in your CFD trading platform.
A buy trade is known as a ‘long’ trade, and it means that you will begin the trade at one price, with the expectation that it will rise.
You then close the trade or sell at a higher price, generating profit on the difference between the selling and buying price.
Therefore, in case you opened the trade at a time when gold was going for $1,350, and closed the trade when the gold price was $1,395, your profit would be $45.
Still on the same example, if you thought the price of gold would decrease, you could open a sell trade in your CFD trading platform.
This trade is referred to as a ‘short’ trade, and it means that you open a trade with the expectation that the price of the asset will fall.
You then close the trade and generate a profit on the difference.
If you, therefore, opened a short CFD trade at a time when gold was priced at $1,350, and later closed the trade at $1,290, your profit would be $60.
CFDs keenly follow the price of the market, the success of your trades, therefore, depends on the market’s performance.
An Example of CFD Trading in a Stock Market
In an example, you choose a stock with an ask price of $15 and proceed to open CFD trade to the value of 200 shares.
In case when buying shares the traditional way, the cost would be $3,000 and there might also be trading costs or commission involved.
Nevertheless, a CFD broker mainly needs just a 5% margin. This will permit you to get into the same trade but with just $150.
It is good to note that exact levels of leverage or margin vary. This makes CFD an attractive hunting space for the intraday trader.
The risk and reward ratio is increased and this makes short term trades more practical.
When you begin your CFD, the position shows a loss equal to the size of the spread from your broker.
This means that if the spread is 10 cents, you’ll require the stock to positively grow by at least 10 cents so as to break even.
In conjunction with the examples of how to CFD trade, it is also good to know the benefits and risks associated with CFD trading.
Benefits of CFD Trading
Accessibility
Good CFD brokers will allow you to trade in all of the main markets.
CFD trading hours effectively run 24 hours a day, as the markets are many.
You need to confirm your broker’s trading hours first.
Leverage
CFD trading offers higher leverage compared to traditional trading. You can have margin requirements of as little as 2%.
The rate normally depends on the underlying asset. Shares or unstable cryptocurrencies, for instance, can reach up to 20%.
While low margin rates will allow you to take big positions with just a little capital, you will also suffer greater losses. This is quite important to note.
Less shorting regulations
There are markets that impose rules which prevent you from shorting at certain times.
The markets can demand bigger margin requirements for shorting compared to being long.
The CFD market, however, doesn’t have such rules, since traders don’t actually own the underlying asset.
This means that with CFD, there is no borrowing or shorting costs.
Cost
CFD trading systems incur little costs. Many brokers charge little or zero fees to enter and exit CFD trades and make their money when you have to pay the spread.
The size of the spread you pay, which is a fixed spread, depends on the stability of the underlying asset.
Diversity
CFD trading is wide and diverse. You can start CFD FX trading, and utilizing treasury, commodities, cryptocurrencies, and index CFDs.
Minimal day trading requirements
Some markets require a substantial fee to get into CFD trading.
This restricts you on how many trades you can make, and also how much profit you can generate.
An online CFD trader can however set up an account with as little as $1,000 to $5,000.
Risks of CFD Trading
Trading on margin
Trade margin increases the potential of profit and also increases risk, as trade margin makes it is easy to lose sight of the total exposure you have as a trader.
$3,000 worth of open positions using 5% margins for instance, mean exposure to $60,000 worth of contracts.
You successfully borrow $57,000 from your broker.
If the markets move against your prediction, losses could be more than deposits.
Regulation
The CFD industry is not well regulated.
It is therefore very important for you to select a good broker who is credible and with a strong financial position
By now I know you have learned how to CFD trade, and you are not asking questions like what is CFD trading? CFD trading has its risks and benefits. Therefore, it is upon you to decide whether it suits you or not.