CFD or Contract for Difference trading allows you to speculate and make profits, on the price movements of various instruments in the financial market. Some of the common instruments of CFD trading are shares, indices, commodities, currencies, and bonds. In this kind of trading, you can also speculate the falling market and make gains with leverage.
Since you are only speculating the price movement of an underlying instrument and not owning it, you will not have to pay stamp duty on the profits. Today, CFD is popular among investors who are actively participating in financial market trades.
Benefits of CFD
- No underlying ownership, so you do not need to pay stamp duty.
- Offers flexibility to earn profit from both falling and rising markets.
- Provides leverage, thereby allowing traders to control bigger value position with small amount of cash.
- It is used as a hedging tool to offset the potential losses on other investments.
- Traders get an opportunity to diversify their portfolio, as they can trade across variety of markets and instruments.
- Gives traders the convenience to trade on index, commodity, and Forex on the same brokerage platform.
Get familiar with margin and leverage
CFD is leveraged trading . It means that you can deposit a small percentage of overall trade value to open a position, which is called margin. Trading on margin is a little tricky. Your losses and rewards are based on CFD position’s full value. It means your returns can increase significantly, but can the losses. You could also lose more than the deposited capital, if you don’t make the right moves.
CFD trading cost
Spread – Spread is the difference between buying & selling price, which you need to pay. The quoted buy price is used to buy, and sell price is applied to exit. Narrow spread means small movements are needed to get a reward (moves in your favor), or incur a loss (moves against).
Commission – Commission fees are subjected only to share CFD trading.
Holding cost – You will have to pay the cost for holding your position, if you continue doing it or even after the closing of the day. Even though it is risky to hold the positions, it can also be a good strategy if you apply the right analysis.
How CFD trading works?
Choose a market
With choices like currencies, shares, indices, bonds, commodities, etc, you get immediate access to key worldwide markets in the US, UK, Australia, Asia, and New Zealand. Make sure that you choose a trusted platform likeEtoro (and read aneToro reviewfor further info), because they also provide a lot of research and analysis tools, to assist their members in making the right trade decisions.
Decide to buy or sell
Two prices are available in CFD market.
- Sell price (quoted) or the bid
- Buy price or the offer
Difference between these two prices is the spread. When you speculate the price of AB Company to increase, then you buy it or ‘go-long’. In case, you believe the price of AB Company to fall, then you sell it or ‘go-short’.
Choose trade size
1 CFD = 1 share in equity trades, but it differs in other instruments. CFD is leveraged, so you need to pay a small amount on the overall trade value. In case the overall trade value is large, then more margins will be needed. Make use of margin calculator provided on the brokerage platform to know the initial margin.
Add stop-limit orders
Risk management strategy is crucial. Placing stop-limit orders is a crucial risk management technique. When the price reaches the specific level that you set, the platform is allowed to close or open. Thus it helps to mitigate losses.
Trade monitoring
After you place a trade and set stop-limit order, then you will need to be patient and watch the market movements. Monitor the market price fluctuations and keep check on your profit/loss real-time updates by using Smartphone.
Close trade
Select ‘close position’ option, your net open trade profit, or loss gets released instantly in your trading account. Even if the stop-limit order is active, you can close the trade.
Kidal Delonix is a contributor to Mr. Hoffman's blog. The views and opinions are entirely his/her own and may not reflect Mr Hoffman's views.
