This section is about trading using what’s called a contract for difference or CFD a contract for difference represents the difference between the price when you buy and sell a CFD of a share index or commodity. Put simply a CFD is a contract between a buyer and a seller. The buyer and seller agree to exchange the difference between the price of a share at the opening and closing of a trade.
The CFD is a popular financial tool because it allows investors to buy or sell a contracted number of shares in a given stock at a certain price for any period of time. There is no physical delivery of a CFD contract nor do you have any of the additional benefits of owning a share such as attending the annual general meeting. You do however take part in dividends and any corporate actions such as bonus shares. All CFD trading is settled in cash money either flows into or out of your account depending upon the success of your trading.
But before we get into the trading aspect, first things first what is an underlying asset? The underlying asset is the price of a CFD stemmed from a physical asset in the market, this is either a share on the ASX foreign exchange market commodity or index the price of the CFD will mirror the price of the underlying market. It’s important to note that see if the traders do not trade or own the underlying asset CFD trades simply involve betting on the future price of a particular asset. Most CFD providers offer a wide range of underlying markets. All CFD providers have a product disclosure statement some are more detailed than others while the document may appear long. It contains vital information. Inside a reputable CFD provider will have detailed information on costs markets and trading examples while also highlighting the risks of CFDs. Make sure you take the time to read it before you open an account this brings me to an important facet of CFD trading that if used correctly can help you make more money with less of your own capital. But should be used with great caution how leverage can help you maximize potential profit leveraging means that you use a percentage of your money with a CFD provider lending you the remaining amount. In other words, when you open a trade you place a deposit upfront generally this is a percentage of the total value of the trade and the CFD provider will lend the remaining value of the trade, this is called a leveraged position. For instance, if you put in 5% of your own money to open a trade of the market value the CFD provider makes up the remaining 95% the value in this is that even though you have only submitted 5% you are entitled to the same gain or losses as if you had paid a hundred percent. Different providers will ask for different percentages. In addition, there are ways to reduce the amount of leverage you use, however even though the CFD provider lends you the remaining amount of money to meet the full trade size you are always responsible for the full value of the CFD trade, so what does the CFD trade look like let’s say the current level of the ASX is five thousand one hundred points. If you believe the market is going to move upwards that is trade higher you would take out a long position in other words you’re entering a CFD trade and think the asx200 will move higher than its current level of five thousand one hundred points because CFDs are leverage you don’t need to outlay a large sum of cash to open a position instead you place a deposit. This is what CFD providers call your margin. Most indices are highly leveraged. It’s quite common to see an index leveraged at ninety-nine to one. If this is the case that means your deposit or margin is only 1% of the value of the trade to open it. For example, if you wanted exposure the total value of your trade to be $50,000 you would buy ten ah z-index contracts which mean ten contracts times five thousand one hundred points, giving you an exposure to the market of fifty-one thousand dollars with 99 to one leverage. You would pay a margin of just five hundred and ten dollars which is one percent of the total value of the trade. If the index rose from five thousand one hundred points to five thousand four hundred points over the next three weeks you would have made a significant profit of three thousand dollars three hundred per CFD times ten contracts. This is a very large increase over your five hundred and ten dollar investment not a bad return by anyone’s standards, but if you get it wrong your losses are magnified to say the index falls three hundred points to four thousand eight hundred, this means you’ve lost three thousand dollars which is your initial investment and much more get the idea. This brings me to a vital point understanding the risks of CFD trading a golden rule of trading is this never trade with money which you cannot afford to comfortably lose you’ve heard it a thousand times but believe it the best guard against this is a realistic view of life, not a belief that there is a magical or mystical force at work. This is science linked with randomness otherwise known as luck CFDs are incredibly risky, it’s vital you understand this your risk is not limited to your stake your losses could be considerably more.
Let’s go back to the Australian index CFD trade to show you what I mean what you have to remember is that with any CFD trade you may have you are always responsible for the total value of the trade. Don’t let any tiny deposit fool you if you take out a fifty thousand dollar trade sighs, you need to be able to back that up if the market moves in the opposite direction of your tray. Look that’s an extreme example, in fact, there’s a good chance the CFD provider would have covered the trade but they will hold you accountable for any money owing again. This is why we don’t recommend using 99 to 1 leverage keep it small before opening any position ask yourself if you can afford to lose the amount that you’re exposed to if you can’t stop right there unlike options where you generally need to take out 100 contracts at a time. The minimum CFD contract is one that gives you the ability to get a feel for trading. You can start by buying or selling one contract at a time in time when you become more comfortable with leverage you can buy more contracts. Make sure you understand the risks you are taking on before you get into investing via CFDs and don’t place trades you don’t understand.
That brings me to the next step how do you place a CFD trade to place a trade just call your CFD provider or log on to their trading platform and enter the trade an example of trade goes like this, say you want to buy tennis trained index CFD contracts this is called buying or going long. If you call the CFD provider you’ll say something like this is John Smith member number of 1400 can I buy tennis trained index contracts 1400 is your unique number allocated to you when you join the operator will give you a number like five thousand one hundred this is the quote number. They have just given you for the Australian index contracts you agree and that’s it your trade has been placed. You will receive a confirmation of your trade, remember most dealers will take the time to help walk you through a trade. When you call them, tell them you’re new to this everyone has to start somewhere, in addition, most CFD providers have extensive online tutorials to show you just how to get started with your first trade. From there you can look at more detailed tutorials one or two CFD providers even have a client services team that will talk you through how to place your first trade over the phone. Take advantage of this information it’s there to help you and finally, you don’t even have to call a dealer. Most brokers have online trading platforms that you can use.
And now to the final question about CFD trading, how much can you trade. This depends strictly on how much you’ve deposited into your account, of course, it is important to remember that if a bet goes against you, you must be able to pay the full value of the trade. Most of the time losses will simply be deducted from the cash in your trading account, always make sure you have the money to cover your losses, never risk money you cannot afford to lose. The trades you are allowed to place depend upon your means income and savings and the cash that you have available in your accountant. Do you need any cash to start? Yes, here’s why: when you open an account you will need to make a cash deposit that will be used as security against any trades that you make. It is important to remember that when trading CFDs you can lose more than the balance in your account. If the market moves sharply against you the CFD provider will email or call you to ask for additional funds to cover your losses. You must be prepared to pay the margin call as it’s known or close out your trade and take the losses. What are the advantages of using CFDs to trade there are several advantages in using a CFD broker compared to a traditional stockbroker. You can make small trades much smaller than the usual minimums allowed in training shares and futures directly. You can deal 24 hours a day even at 3 a.m. most stockbrokers don’t take kindly to being woken at this time of the morning though. You can deal immediately. They quote a price and if you take it the deal is done on the spot. You do not have to wait for the deal to be executed in the underlying market. Finally, with the exception of share CFDs, there is almost no commission to pay. They make their money on the spread of their quotation. You should also be aware of something called a financing charge which is applicable when trading CFDs on shares sectors in indices but not on commodities but simply because you are borrowing funds from your CFD provider in order to trade. The performance of an actual share you need to pay interest to the CFD provider just like when you have borrowed to buy a house or a car. This is called financing and is usually referenced to a benchmark interest rate finance charges vary depending on the CFD provider. However, it can be about two percent or three percent above the relevant benchmark interest rate for that country. Check with your CFD provider to see their charges all of this information will be in a CFD providers product disclosure statement. If it’s not, get another provider this information should be clear and disclosed upfront. Always make sure to read the CFD providers PDS, it contains all the legal information you need to know about CFDs.