Understanding the Basics of CFD Trading
CFD, which is an abbreviation for Contracts for Difference, is a type of market trading that is currently attracting a growing number of retail traders all around the globe. CFD trading is simply an agreement that is reached upon by two parties to exchange the final difference gotten between the opening and closing prices of a contract.
Regardless of whether there is a rise or fall in prices of financial markets, their price movements can be speculated and traded on using CFDs. You can buy (go long) or sell (go short) a CFD market. When you go long, you profit from the rising prices while when you go short, you also benefit from the prices as they fall. With CFDs, you have a great trading flexibility deal that allows you always to profit from the financial markets, irrespective of the price direction.
CFD Trading Leverage
For an investment that you would usually need to trade directly on the underlying assets, with CFD trading, only a small percentage of it is required. Considering that it is a leveraged product, you can maximise your market exposure with very little at hand.
How to do CFD Trading
When doing CFD trading, you place a trade with a reliable CFD provider such as CMC markets on the particular instrument that you choose. Some of the instruments that are regularly offered include:
The prices of the CFD markets typically replicate the exact amount of the key asset, given that you a gain or loss depending on the upward or downward shifts witnessed in the price of the relevant market. Also, there is a small commission that is charged on all CDF share markets for every trade placed with a CDF provider. What’s more, the non-equity markets are typically commission free, but they are known to incur an extended spread.
How CFDs Work
Just as is the case with the traditional share dealings such as forex trading, the CDF prices are cited as bids and offers. These are basically the prices at which they can be sold or bought at. CFD tradings are on margins, which are commonly referred to as leverage. What this means is that, for anyone to open a trade position, an initial margin has to be made. In other words, a given ratio of the value of the instrument in play has to be deposited.
The initial margins frequently vary depending on the market, although, they are typically between 2-5% for currency trade or index trade and 10-25% for an equity trade. As such, CFD trading gives the likelihood of a much better return on investment than paying the full amount for the trade.
With CFD trading, you have an equal opportunity when it comes to losing or gaining. If the markets move in your favour, your gains are magnified. Equally, if the markets go against you, your losses are magnified with the same intensity. However, there are a number of risk management tools that can help you manage your CFD trading efficiently, including:
- Standard Stop Loss Orders
- Trailing stops
- Guaranteed stop loss orders
Standard Stop Loss Orders
Stop loss order is a risk reduction tool that allows you to close a losing trade when the market passes the trigger value that is set by you. In other words, you can close trades automatically if the markets move against you, and cut your losses. This, in turn, helps to limit your downside exposure. However, the standard stop loss orders are not very dependable because it is only until the stop value has been triggered at the next available price that the order will close your trade.
When the market is volatile, for example, market gapping can occur. This means that your trade could be closed out at a different level from your trigger value.
These are risk management tools that help to minimise the potential losses without limiting your potential gains. A trailing stop is formed by setting a particular stop order by a specific number of points that trails your position. If the market trade moves in your favour, then the trailing stop moves along with the market. However, when the markets move against you, the trailing stop executes by the number of set points.
Guaranteed Stop Loss Orders
In all the risk management tools, these are the most efficient ones. When you place particular trigger values, they guarantee to close the trades exactly at the values set. It does not depend on gapping or market volatility, making it quite reliable. However, they are ordinarily not available for illiquid trades.