Contract for differences, or CFDs, are leveraged trading products that mirror underlying markets. Organised as a contract between buyers/sellers, CFDs are widely employed to speculate on price movement, without taking ownership of the underlying asset. CFD shares, for example, mirror the underlying stock price, or sometimes referred to as share price.
CFD trading, successful CFD trading that is, requires discipline and perseverance. Consistency is earned through hard work. There is no secret sauce. To help, however, the research team at FP Markets joined forces and have laid out five need-to-know tips.
Use a demo account.
A simulated trading environment enables retail traders to get their feet wet and start trading share CFDs, in a risk-free space.
An online demo trading platform is an ideal stepping stone into the world of financial trading.
A demo account provides a space to get acquainted with the broker’s platform, allowing traders to familiarise themselves with different order types and charting tools. Additionally, testing a trading strategy on a demo before unleashing it in the live market is generally recommended.
Demo trading accounts are offered by most CFD brokers. With FP Markets, we offer an easily accessible demo account experience, though do note demo accounts are removed automatically after one month of inactivity.
Employ protective stop-loss orders.
A protective stop-loss order is in place to keep you in business. It protects you from making the mistake of thinking you know better than the market.
A common mistake, particularly among newer traders, is altering protective stop-loss orders while trade is in motion. Just to be clear, some circumstances call for moving a protective stop, such as reducing risk to breakeven or trailing a position to lock in profits. Yet, it can be destructive to modify a stop that increases the potential for further loss.
The bottom line – setting a protective stop-loss order is key in any risk-management system.
Understand your market.
Ensure you understand what share CFDs are before pulling the trigger.
Trading stocks (or sometimes referred to as equity trading) outright in the stock market and entering into a CFD agreement are two entirely different things.
Holding physical shares entitles the holder to specific rights, while trading equities with CFDs those rights are limited as shares never change hands. Share CFD positions, however, are adjusted to offset changes from dividends.
How you make trading decisions is important.
Are you a chart-based trader, with a focus on technical analysis?
Are you a fundamental trader, concerned with company-specific events?
Or do you focus on a combination of the two?
Whether you’re a day trader (day trading), swing trader or position trader, consistently profitable CFD traders not only have a trading plan in hand, a comprehensive blueprint detailing each step of their trading activity, they also recognise the operation behind buying and selling any financial instrument.
New traders may find FP Market’s Traders Hub particularly helpful, offering daily technical and fundamental analysis from industry experts.
Leverage is a strategy that allows traders to increase their exposure with minimal outlay. Leverage is a double-edged sword, however.
While leverage can increase profits, it can just as easily increase losses.
Share CFDs are leveraged products, meaning you only deposit a small percentage of the total position value in order to execute a trade. This is referred to as trading on margin or margin trading.
Scaling leverage to an acceptable risk level is vital. Don’t be tempted to risk more than what you’ve specified in your trading plan.
How Share CFDs Can Earn You Money
Ultimately, CFDs are used for two things: to speculate on rising and falling prices and to hedge, a popular strategy to offset potential losses.
With share CFDs, along with other derivative products, such as futures and options, traders are able to freely buy and sell stocks as there is no ownership of the underlying shares – it’s simply an agreement between two parties.
Market speculation is ultimately where CFD share traders can acquire the bulk of their profits. This can be through a technical-based trading strategy, a fundamental approach, or a mixture of the two. The latter is generally favoured.
In addition to profits derived from price movement, dividend adjustments can also generate returns. Holding a long position in share CFDs, before the ex-dividend date, entitles the holder to a payment equivalent to the amount of the dividend. The holder, in this case, receives a credit to their account. A short position in share CFDs, on the other hand, incurs a debit, essentially owing to the equivalent of the dividend value.