The CFD Tutorial
Specialization means better information and better information means power when you are a trader.
What is CFD? A CFD (Contract for Difference) is a financial derivative product that can trade any financial market (Currencies, Equities, Commodities, etc.) by offering high capital leverage. You can trade any financial instrument without the need to own it.
Introduction to CFD Trading
A CFD contract allows traders to speculate on any financial instrument by mirroring its price movement. In other words, you can trade any instrument without the need to actually own it. In addition, the ability to leverage trades means you can own large positions with small amounts of capital. The profit/loss of any trade is calculated by the difference between the buy/sell price.
The Need for CFD Brokerage
CFD trading requires opening a trading account with a CFD broker. CFD brokers usually don't charge any commissions and the only cost for traders is the spread between ask and bid. You can find CFD brokers at the end of this trading guide.
CFD Trading Features
CFD trading has become highly popular among world investors. These are the main reasons for the increased popularity of CFD trading.
(1) Trade 24/5 via desktop or mobile devices
(2) Trade rising or falling markets, choose among a wide variety of trading orders
(3) Choose among thousands of different financial products to trade (Forex, Equities, Commodities, etc.)
(4) Choose from hundreds of different CFD brokers and take advantage of their promotions (deposit bonus, no deposit bonus, trading rebates, etc.)
(5) Trade CFDs via the simplicity of a WebTrader platform or trade CFDs via the advanced MetaTrader platforms
How CFDs Really Work?
A CFD contract is designed to trade the price movements of any financial instrument without the need of owning that particular instrument. That means that a CFD contract is able to mirror the price fluctuations of almost any traded financial asset.
When a new CFD position is opened, the profit/loss of this position is determined by the difference between the opening and the closing price of the underlying financial asset. A CFD trade can close in three ways:
(i) If the price of the underlying financial instrument touches the take-profit price
(ii) If the price of the underlying financial instrument touches the stop-loss price
(iii) The trade can close also manually by the trader anytime he wants to
Example of a CFD Trade on EURUSD (Calculating the Profit/Loss)
For example, let's assume that a Forex trader buys 1 lot of EURUSD at 1.1002 and sells it at 1.1022
-Initially, EURUSD is bought and sold at 1.1000 / 1.1002 (bid/ask)
-In order to buy 1 standard lot (100,000 USD of value), the trader needs to have about $500 in his account (that means leverage 200:1)
-As the position is opened the trader notices that his account is charged with about $20. This is due to the difference between ask and bid (in our example 1.1000 / 1.1002, which means 2 pips spread)
-As EURUSD moves 20 pips higher, the trader decides to close his position
-The new Ask/Bid is 1.1022 / 1.1024
-The trader closes his position at 1.1022
-The profit is calculated as 1.1022 – 1.1002 = 20 pips
-20 pips of profit equal about $200
The Advantage When Trading on Margin
When a trader buys shares of a company, he has to pay the full value of these shares or he can pay 50% of the value of the shares if the stockbroker allows it. Trading CFDs or other similar derivatives works differently. CFD traders don't have to pay 50% of the value of the assets they buy. CFD brokers usually offer leverage up to 50:1, or even more. That means in order to trade $100,000 worth of shares you need to have 2% of the value of the position in your trading account. In other words, you can trade $100,000 with just $2,000 in your trading account. That is an advantage only if you are not greed. If you tend to leverage all your trades up to 50:1, or more, there is a 90% probability that you will lose your capital. Professional traders avoid to leverage their trades more than 20:1 and avoid to dedicate more than 2% of their entire capital in a single trade position. Don't try to outsmart these professional traders, they know better.
The Cost When Trading CFDs
These are all the fees and commissions charged by CFD brokers that you should know about before start trading CFDs.
(1) Trading Spreads
CHECK SPREADS: at CFD broker's website
All financial assets are offered with two prices (ask and bid). The spread is the difference between ask and bid. Almost all CFD brokers charge spreads and nothing else. The minimum spread you will usually pay when trading CFDs is about 1.3 pip on EURUSD. A clever way to reduce your trading cost is to join a Trading Rebate Plan.
■ Learn more about rebates at Forex-Rebates.com: www.Forex-Rebates.com
Be Aware of Re-Quotes
A re-quote means that when you open a trade position the price you pay is worst than the one you have entered. That means extra cost. Re-quotes usually occur in fast-moving markets, such as markets after important news announcements. You can protect your account from re-quotes by placing a pending order (limit order) and not an instant execution order. When you place a limit order, you state that you are willing to open a trade position at a specific price or better.
(2) Trading Commissions Charged
CHECK COMMISSIONS: at CFD broker's website
CFD brokers don't usually charge trading commissions. But some CFD brokers offer Zero-Spread account types by charging trade commissions. These commissions are calculated on a round lot basis.
(3) SWAPs / Overnight Financing
CHECK SWAP CHARGES: at CFD broker's website
The SWAP rates exist in order to balance the overnight cost of money as it is expressed by overnight interest rates.
As CFDs are traded on margin when you open a long or a short position it becomes the subject of interest rate charges as any other cash transaction. This is because money is involved in order to finance the purchase. The SWAP rates can be debited or credited. The difference on positive/negative swap charges depends on the asset you are trading and the direction you are trading.
The SWAP cost applies every calendar day at the end of each trading day at midnight (according to your broker's server time). The SWAP rate amount is tripled on Wednesdays in order to cover Saturday and Sunday. That means the SWAP rates are applied 365 days per year.
The SWAP rates can be either positive or negative. For example, if you trade a Forex pair such as AUDUSD or NZDUSD the difference is positive and it is credited in your trading account. If you trade USDZAR the difference is negative and it is removed from your trading account.
Explanation of SWAP Rates in Forex
As currencies are traded in pairs, each time a transaction occurs, one currency is purchased and one currency is sold. There are Forex currencies offering high-interest rates (NZD, AUD, etc.) and other currencies offering low-interest rates (USD, EUR, etc.). When you trade any Forex pair, the difference in the interest rates of the two currencies may be positive or negative:
(i) if the difference is positive, then a swap amount is credited overnight,
(ii) if the difference is negative, then a swap amount is debited overnight.
Note, that if you trade commodities or equities, the SWAP rates will be always negative.
Avoid SWAP Charges via CFDs on Futures
A very smart way to avoid paying SWAP rates is to buy CFDs on Futures. For example, if you buy the USD30 Index via a CFD on Futures you will pay a greater spread but you will not pay any SWAP charge until the contract ends. Usually, CFD on Futures last 2-3 months and mirror the price movement of the underlying asset exactly the way a simple cash CFD contract mirrors it. If you are a swing or a long-term trader, CFD on Futures is your best weapon to make money.
(4) Funding (Deposit/Withdrawal) Fees
CHECK THEM OUT: using each CFD broker's live chat service or via email
Funding fees and commissions are charged either on deposits either on withdrawals. Most CFD brokers don't charge this kind of fees.
(5) Maintenance/ Inactive Fees
CHECK THEM OUT: using each CFD broker's live chat service or via email
Some brokers may charge fees for inactive accounts. These fees are called Maintenance/ Inactive Fees. Most CFD brokers don't charge this kind of fees.
Some Important Tips When Trading CFDs
These are some key tips when you are trading CFDs:
(1) Limit Your Deposits
Don't deposit too much on your trading account, that can make you riskier. Deposit as much you need to cover your initial trading positions.
(2) Limit your Individual Risk
Leverage your trade wisely. Think of your entire capital and don't risk more than 2% on any individual position. If you hold USD10,000 then don't risk more than $200 on any individual trade.
(3) Place Pilot Orders
Never open a trade position before you have calculated the cost of your stop-loss. For example, if you want to risk no more than $200 on a single trade, open a pilot position of 0.01 lot and check your stop-loss. If you see that the 0.01 lot trade results in $20 risk then you now that you need to open an additional position of 0.09 in order to risk no more than $200. These pilot orders are very useful. An alternative is to use a demo account and place your pilot orders there before you execute them on your real account.
(4) Trade What You Know
You will enjoy more success when you trade assets that you already know, especially if you watch them closely. Avoid the unknown, and again use pilot orders when you trade assets for the first time. Most professional traders are specialized not only to certain markets but even to particular instruments on those markets. For example, there are many professionals trading only Gold, or only Crude Oil, or only US30, or only EURUSD. Specialization means better information and better information means power when you are a trader.
Regulated CFD Brokers
Here are some CFD brokers that are regulated and offer segregated client bank accounts. All the following companies are large and have been operating in the market for at least 5 years.
REGULATION / ACCOUNT FOUNDATION
REGULATED: FCA UK
■ Sirix WebTrader
$100 Minimum Deposit Amount
► FXCC Web
■ CFD Tutorial