CFD Trading

CFD Trading
What are CFDs?

What is CFD Trading?

CFDs or (Contracts for Difference) are a popular form of derivative trading that allow you to speculate on the price movement of a financial instrument. The global markets are accessible to all trades from Ireland giving them the possibility to trade a wide range of assets without actually owning them. Common examples of derivative instruments include Forex, Shares, Commodities, Metals, and Indices.

Unlike traditional trading where you actually purchase an asset, CFD trading involves an exchange on the price difference of the underlying instrument between two time periods - the opening price of the contract and the closing price. It is easy to distinguish CFDs from other forms of derivatives as they do not have a fixed expiry date. As a result, CFD traders can keep the contract for the short term or leave the order open for an extended period.

One advantage of trading CFDs is that you can speculate on price movements in either direction, up or down. This means that traders can take advantage of falling markets by employing a short-selling strategy. Other advantages of CFD trading include access to a wide range of markets and leveraged product offerings.

Some consider CFDs to be a complex instrument. The video below explains how CFDs offer a cost-effective way to trade global financial markets including the NASDAQ and NYSE along with the United Kingdom's LSE.

Video: CFD Trading
Explained

How Do CFDs Work?

A Contract for Difference (CFD) is a highly leveraged product. Traders are able to get larger exposure to price movements without having to invest the total trade value. This concept is known as margin trading. Only the difference in the prices is required to be present in your trading account in order to execute the trade.

Trade CFDs - What is
CFD Margin?

You will need to open a margin account to Start Trading. The level of leverage will vary on your account type and the financial instrument you are trading. For instance, higher levels of leverage are offered on major currency pairs such as the EUR/USD than on share CFDs.

It is essential to remember that leverage can work both ways, providing significantly larger profits, but also magnified losses. Leveraged products are considered high risk, making risk management a vital strategy for all Irish retail investor accounts.

A minimum amount of capital must be present in a trading account at all times to serve as a cushion against potential losses. This is known as the 'initial margin'. It is the difference between the funds you borrow from your broker and the full trade value of your position. In circumstances where the capital in an account does not cover the trade, the broker will issue a 'margin call'.

Suppose the shares of XYZ Company are trading at $130 per share. You decide to buy 10,000 units of a contract at this price. Now, if you had to pay the total value of this contract, it would cost you:

$130 x 10,000 = $130,000.

By using leverage, you can gain exposure to the same number of shares, but with a lower capital investment. If the required margin is 5% of the total trade value, you will be required to pay only $6.50 per CFD unit, in your trading account as margin.

So, your total margin requirement will be
(0.05 x 130,000) = $6,500.

This is significantly less than $130,000 but you get the same level of exposure, as if you had bought the shares directly. Plus, you are entitled to 100% of the gains. On the other hand, you will also bear 100% of any losses.

This margin percentage will depend on the country from where your trade. Different regulatory bodies have different limits for leverage. These limits have been put in place to protect traders against significant losses during time of heightened volatility.

Going 'Long' or 'Short'

One of the biggest attractions of CFD trading in Ireland is the ability to trade in rising and falling prices of an underlying asset. An anticipated prise rise will initiate the purchase of an underlying asset and taking a long position. In contrast, taking a short position and selling the asset would result in a profit if the price were to fall. Short-selling is one of the unique aspects of CFD markets.

Leveraged CFD Trading Example

For the following example, let's suppose that you want to trade the FTSE 250, a capitalisation-weighted index consisting of some of the largest companies in the United Kingdom. At the time of the proposed order, the FTSE 250 is trading at:

Bid/Ask Spread

A significant advantage of CFD trading is the opportunities to hedge your portfolio against short-term market volatility, within an existing position. Hedging is a risk management strategy to protect against an unwanted move in the market.

Assume you buy 5 contracts of FTSE 250 and your margin rate is 1% . This means that you need to deposit 1% of the total position value into your margin account as shown below.

In a matter of hours, if the price moves to 22100.00/22112.00, you would be in a 100 position to have a profitable trade. Closing your position by selling at the current (bid) price of FTSE 250 which is 22100.00 would result in a net gain.

The above example displays a favourable pricemovement but had the price declined instead, closing out the trade would have incurred a loss. This continuous evaluation of price movements highlights the day trading nature of forex and CFD trading.

In the event where a loss is incurred and your equity, (account balance Profit/Loss) falls below the margin requirements (1105), the broker will issue a margin call. If you fail to deposit the outstanding amount and the market moves further against your position a 'stop out' may transpire. When your free equity reaches 50% of your initial margin, the contract will be closed at the current market price, known as the 'stop out'.

This small difference is known as “pip” or “percentage in point.” For Indices, 1 pip is equal to a price increment of 1.0 which is also called an Index point. In the forex market, like in the above example, it is used to denote the smallest price increment in the price of a currency. For assets like the AUD/USD, which include the US Dollar, a pip is represented up to the 4th decimal place. But, in case of pairs that include the Japanese Yen, like the AUD/JPY, the quote is usually up to 3 decimal places.

If the price
of FTSE 250
To You Could Gain or Lose
(for a long position)
Rises by +1% 22300.80/ 22312.80 USD 1044.00
Declines by -1% 21859.20/ 21871.20 USD -1164.00

How to Hedge
Using CFDs?

A significant advantage of CFD trading is the opportunities to hedge your portfolio against short-term market volatility, within an existing position. Hedging is a risk management strategy to protect against an unwanted move in the market.

Let’s say you are a CFD trader in the United Kingdom with an equity portfolio worth GBP 100,000 and comprised of prominent shares on the FTSE 100 index. These are split up in 10 tranches of GBP 10,000 each. You could own GBP 10,000 worth of Barclays shares and GBP 10,000 worth of BHP.

Now, if you believe that both these companies might suffer a short-term dip in share price, due to a bad earnings report, you could offset some of the potential loss by short selling them through a CFD.

Instead of selling these shares in the open market, you assume two CFD short positions in Barclays and BHP.

About 10% of the market exposure, which is GBP 2,000, could be required to carry out this hedge.

Opting the CFD route rather than selling the shares and buying them back later has several advantages.

  • You will attract capital gains when you sell your shares, which is taxable. This will be unnecessary, unless you want to get rid of these assets once and for all. In CFDs, you won’t need to pay stamp duty and trading costs will be limited to margin and spread.

  • If the market does go downwards, the losses in your equity portfolio will be offset by your short CFD positions.

Hold Period

Now, after the market closes each day, any CFD position open in your account could incur holding costs. This depends on the applicable holding rate, as well as the direction of your position; based on which the cost can be negative or positive. Those who trade CFDs should always factor in the holding cost.

Start Trading Forex with an
Australian Regulated Broker

How Do You Start
Trading CFDs?

Take a look at these
6 steps to start trading CFDs:

Step 1 |
Build Your Knowledge

Reading through the process is part of Step 1, but the learning process should not end here. You should consume as much content as you can to develop a sound understanding of CFDs and how to trade them. You can access in-depth articles, expert analysis and webinars on our Traders Hub Blog.

Step 2 |
Open an FP Markets
Trading Account

Register and open a CFD trading account with a regulated CFD broker. With FP Markets you can access multiple trading platforms which provide an array of robust risk management and trading tools. Those who are completely new to CFD trading can open a free Demo Account and practice trading with virtual currency. This will allow you to harness concepts of margin requirements and leverage which are essential aspects of CFD trading.

The benefits of trading with a regulated broker such as FP Markets include

  • Segregated client funds

  • ECN pricing

  • Advanced trading platforms

  • Deep liquidity from top-tier liquidity providers

    .

  • Ultra-competitive spreads from 0.0 pips

    Maximum leverage

    10,000+ financial instruments

    Traders Hub Blog - educational resources

    News and Economic Calendar

    Secure trading and fund transfer
    We pride ourselves on offering award-winning customer support. Our dedicated multilingual customer support team is available 24/7^^. Contact us using a variety of methods including

Step 3 |
Create a Trading Strategy

This is extremely important and no trader should begin executing trades without one. Factors to consider include trading capital, risk appetite, market knowledge, goals, preferred strategies and tradable instruments.

Risk management is an essential part of every trading plan and ensures longevity in CFD trading. Our range of eBooks can help you develop a successful trading plan.

Step 4 |
Fundamental and Technical
Analysis

When attempting to identify trading opportunities, there are two market analysis methods, namely Fundamental Analysis and Technical Analysis. Fundamental analysis focuses on the overall state of the economy by looking at a wide range of factors. They include geo-political events, economic data and breaking news that can have any impact on global financial markets.

In contrast, technical analysis is the study of historical price action to identify patterns and predict future movements in financial markets. Advanced CFD trading platforms such as MetaTrader 4 and MetaTrader 5 have a wide range of pre-installed indicators and charting tools that allow traders to conduct comprehensive market analysis.

Step 5 |
Choose Your Trading Platform

MetaTrader 4 and MetaTrader 5 are complete trading platforms. They provide a wide range of tools that track price fluctuations and have an in-built feed of market news. They also provide a demo account option which allows new traders to develop a trading style without risking any capital.

Step 6 |
Risk Management

Risk management is essential for every trade, regardless of the market conditions or size of the position. To restrict potential losses, here are some tools you can use:

Stop Loss Order: By placing a stop loss order, traders are able to direct the system to automatically close a position when the market reaches a certain price level. This can minimise losses when the market moves in an unfavourable direction.

Take Profit: This order closes out your position once you have gained a specific level of profit. This protects your positions from unnecessary market risk and locks in a return that is aligned with your risk appetite and trading plan.

Trailing Stop: Are used to protect gains. This moves your stop-loss further if the market goes in your favour, but as soon as the market reverses, it closes the position. This order prevents your positions from getting closed too early.

For more in-depth fundamental and technical analysis plus trading education, please visit our Traders Hub blog.

Advantages of CFD
Trading

Wide range of financial markets: CFD trading with FP Markets allows you to access the biggest financial markets from around the world. Our CFD offering consists of 10,000+ tradable instruments across Forex, Shares, Indices, Metals, Commodities and Cryptocurrencies. This includes currency pairs such at the USD/AUD along with stocks in some of the world's biggest companies including Apple and Amazon.

Trade in falling markets: One of the unique features of CFD trading is that they provide you with the ability to go 'long' or 'short'. In typical financial markets trading can only take a 'long position' and benefit from rising prices. In contrast, you can open a 'short position' and benefit from declining price movements. This provides traders with additional trading opportunities.

No stamp duty: As you do not own the underlying asset, there is no stamp duty associated with CFD trading. In addition, through the use of leverage, traders are able to make effective use of their capital by gaining greater exposure using margin trading.

Leverage: Offers a cost-efficient way to invest as you only have to deposit a fraction of the trade's full value (margin) to open a position. The margin required varies depending on the instrument, liquidity and other factors.

Effective hedging tool: A significant advantage of CFD trading is its use as a hedging tool. It can be utilised to hedge your portfolio against short-term market volatility within an existing position. Hedging is a strategy that CFD traders use rather than selling holdings in other instruments that may have associated tax implications.

Mirror trading the underlying market: CFDs are designed to mirror the trading environment, including prices, of their underlying market. Buying an Amazon share CFD is the equivalent of purchasing a single Amazon share that is traded on the NASDAQ.

No fixed expiry: Unlike other derivatives such as options and futures, CFDs do not have an expiry date. You can hold CFDs for as long, or as short, as you want.

CFD Trading - FAQ

There are three figures to consider when it comes to CFD trading - 'Bid', 'Ask' and 'Spread'. 'Bid' (sell) is the sell price which is generally displayed on the left while the 'Ask' (buy) price is the higher of the two and the rate at which you buy the asset. The difference between these two prices is the 'spread' and is the cost of trading. Depending on the liquidity of your asset, the spread can be tight or wide.

Start Trading
in Minutes

Open an account now

bullet Access 10,000+ financial instruments
bullet Auto open & close positions
Take advantage of rising and falling markets
bullet News & economic calendar
bullet Technical indicators, charts & alerts
bullet Many more tools included

By supplying your email you agree to FP Markets privacy policy and receive future marketing materials from FP Markets. You can unsubscribe at any time.





Get instant Updates in Telegram
Sitemap | © FP Markets 2020