CFD Trading for Beginners

CFD or Contract of Difference is an interesting way of trading the financial markets where traders make profits from the price fluctuations as anticipated by the trader without actually owning any financial asset. CFD trading is also considered as derivative trading, as the traders do not have to buy or sell the actual financial asset, instead the profits are derived from the speculation made by them.

CFD trading is an acronym used for “Contract of Difference” which is an agreement or a contract between the trader and CFD broker allowing traders to make money simply by anticipating the market price movement. The profits or losses made in CFD trading depends on the extent to which your anticipation is right. Traders can speculate the price movements in either direction and can benefit from it.

Features to Know About CFD Trading

Some of the important features of online CFD trading are:

Short and Long Trading:

CFD trading allows traders to benefit from price movement on either side of the market. In other words, traders can make profits in bullish as well as bearish markets unlike conventional trading. For eg. If traders depict that the price of any underlying asset is going to decrease, they can place a sell underlying asset order and make profits from the difference in price between when the position was opened and when it closed. In this case, traders will only make profit if the prices go down, and if the prices increase, traders will lose and vice versa. With both long and short trades, profits or losses are realised when the trade is closed.

Leverage in CFD Trading:

CFD trading is leveraged and traders can open large trading positions without committing the full cost of the trade. While leverage can amplify the potential profits, it can also amplify the risks in the trade. This means that both the profits and losses are magnified. Losses can become more than the initial deposits. Therefore, it is very important to keep in mind that the profits or losses will be calculated on the full size of the position. Also consider to pay extra attention to the ratio of leverage used and the risks are affordable.

Margin in CFD Trading:

Leverage is also referred to as “trading on margin” or “margin trading.” Margin is the minimum amount that is required to open and hold a CFD trading position on a CFD account. In CFD there are two types of margins required- first, a deposit that is required to open and maintain the position in case of incurred losses. Second, additional funds in the account. Traders receive a margin call from their CFD broker and traders will be asked to add more funds in the CFD account, and if the required amount is not added, the position gets automatically closed and losses incurred become realised losses.

Hedging with CFD:

CFD can also be used to hedge against the losses incurred in the current portfolio. For eg. If the trader anticipates any short term downfall in the price of the underlying asset, they can go short in the market and limit their potential losses. Hedging like this helps in gaining profits with any drop in prices.

What Financial Instruments Can You Trade via CFDs?

With online CFD trading, traders can trade a wide range of markets via CFDs like – CFD forex, CFD indices, CFD Commodities, and CFD Cryptocurrencies. Traders do not need to actually buy the underlying asset to trade them in these CFD markets.

Mechanism of CFD Trading

Commissions and Spreads:

The prices in CFD trading are quoted as buying price and selling price.

  1. Buy Price: Buy price or ask or offer price is referred to as the price at which trader can open a long CFD position
  2. Sell Price: Sell price or bid price is referred to as the price at which the trader can open a short CFD position

Sell price is always slightly lower than the current market price whereas the buy price is always slightly more than the current market price. The difference between the buy/ ask price and sell/bid price is known as the spread.

The trading costs are generally covered in the spreads which means buy and sell prices are adjusted to reflect the overall trading costs.

Position Size:

CFD trading is carried out in standard lots. However, CFD brokers offer traders flexibility in choosing position size of their trade, depending on the underlying asset being traded.

Duration of CFD Trades:

Generally, CFD trading doesn’t have any expiry date, unlike option trading. The CFD trades are closed by opening in the opposite direction to which the trade was opened. For eg. a buy position of any underlying asset is closed by opening a sell position and selling the underlying asset.

If CFD positions are kept open beyond the daily cut-off time, an overnight funding is charged. The cost referred is the cost that is lent to the trader by the provider to open a leveraged trade. With the exception of being a forward contract, it has an expiration at some time, all the overnight funding charges are included in the spreads.

Profit and Loss:

To calculate the profits and losses there is a formula that is used. Deal size of the position is multiplied with the value of each contract, then the figure obtained is multiplied by the difference in points between the price at which the contract is opened and the price at which the contract is closed.

Therefore the formula can be expressed as:
Profit and loss = (number of contracts x value of each contract) x (closing price – opening price)

CFD Markets That Can Be Traded via CFDs:

Online CFD trading has opened a wide range of CFD markets to the traders without owning any of the underlying financial assets. Traders can trade markets including CFD Forex, CFD Indices, Commodities and Cryptocurrencies.

CFD Trading for Beginners:

Beginners might find CFD trading overwhelming, however, traders can consider the following tips helpful trading CFDs

  1. CFD Demo

    It is preferable if beginners start out with a CFD demo account to familiarise and get a feel of the CFD platform. Beginners can test their trading strategies using virtual currencies and polish their trading skills, before committing to any real money.

  2. Stick to the Financial Market That You Understand the Most

    There are a number of CFD markets for trading and any one can be chosen to trade with. Traders must stick to the CFD market that they are familiar with. Once you start gaining confidence in one CFD market, you can diversify your portfolio.

  3. Start With Small Trade Sizes

    Beginners should start with small trade sizes to avoid facing losses in the initial phase. This will help in limiting the risks. It is better if the risk is limited to only 1- 2% of total CFD account capital.

  4. Use Strict Risk Management

    Implying strict stops is very crucial when it comes to CFDs. CFD markets move more rigorously than conventional markets that can lead to losses. It is wise to keep the emotion out while trading CFDs. Successful traders never neglect using strict stops regardless of their trading experience.

The CFD markets being highly volatile are risky. However, traders can make profits if they gain extensive knowledge and skills.