Top Advice On CFD Contracts Trading For Beginner Traders

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CFD Trading 2020 – Tutorial and Brokers

Day trading with CFDs is a popular strategy. The leverage and costs of CFD trading make it a viable option for active traders and intraday trades. This page provides an introductory guide, plus tips and strategy for using CFDs. We also list the best CFD brokers in 2020.

Top 3 CFD Brokers in Russia

What Is A CFD?

A CFD is a contract between two parties. They agree to pay the difference between the opening price and closing price of a particular market or asset. It is therefore a way to speculate on price movement, without owning the actual asset.

The performance of the CFD reflects the underlying asset. Profit and loss are established when that underlying asset value shifts in relation to the position of the opening price.

When trading CFDs with a broker, you do not own the asset being traded. You are speculating on the price movement, up or down.

CFD Example

Lets use an example. Say you select a stock with an ask price of $25 and you open a CFD to the value of 100 shares.

If buying shares the traditional way, the cost would be $2,500. There might also be commission or trading costs.

However, a CFD broker will often require just a 5% margin. This will allow you to enter the same trade but with only $125. (Actual levels of leverage or margin will vary). This makes it an attractive hunting ground for the intraday trader. The risk and reward ratio is increased, making short term trades more viable.

When you enter your CFD, the position will show a loss equal to the size of the spread. This means if the spread from your broker is 5 cents, you’ll need the stock to appreciate by at least 5 cents to break even.

CFD vs Stock

Using the above example: Let’s say the price of the underlying stock continues to increase and reaches a bid price of $26.00

If you owned the stock, your holding is now worth $2600. A nice profit – ignoring commission or trading costs the trader realised $100.

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However, with the underlying stock at $26.00, the CFD would show the same $100 profit – but it required way less to open, just $125. So in terms of percentage, the CFD returned much greater profits. Had the market moved the other way, losses relative to our investment would have been larger too – both risk and reward are increased.

There are of course other benefits to owning an asset rather than speculating on the price. We also ignored commissions and spreads for clarity. But the above does illustrate the relative differences in the two methods of investing.

Application

As you are day trading you probably won’t hold any CFD positions overnight. Instead, you’ll likely place a high number of CFD trades in a single day. To maximise your returns you’ll want to concentrate on liquid volatile markets. CFD trading with oil, bitcoin, and forex are all popular options, for example.

CFD Benefits

You may have already gleaned a couple of advantages above from CFDs, but let’s break them down and add a few more.

  • Leverage – CFD leverage is much higher than traditional trading. You can get margin requirements as little as 2%. The rate usually depends on the underlying asset. Shares or volatile cryptocurrencies, for example, can reach up to 20%. Whilst low margin rates will allow you to take big positions with less capital, losses will also hit you harder.
  • Accessibility – The best CFD brokers will allow you to trade in all of the major markets. With so many markets that means CFD trading hours effectively run 24 hours a day. You’ll just need to check your brokers trading hours first.
  • Cost – CFD trading systems incur minimal costs. You will find many brokers charge little or zero fees to enter and exit trades. Instead, they make their money when you have to pay the spread. The size of the spread will depend on the volatility of the underlying asset. Note it is usually a fixed spread.
  • Less shorting rules – Some markets enforce rules that prevent you shorting at certain times. They can demand greater margin requirements for shorting as opposed to being long. The CFD market, however, generally doesn’t have such rules, as you’re not actually owning the underlying asset. This means no borrowing or shorting costs.
  • Less day trading requirements – Some markets require significant capital to start trading. This limits you to how many trades you can make, and in turn how much profit. An online CFD trader, however, can set up an account with as little as $1,000 to $5,000.
  • Diversity – Whatever peaks your interest, you’ll probably find a CFD vehicle. You can start CFD FX trading, as well as utilising treasury, commodities, cryptocurrencies, and index CFDs.

CFD Risks

Despite the numerous benefits, there remain a couple of downsides to CFDs you should be aware of.

  • Regulation – The CFD industry is not thoroughly regulated. This means it’s increasingly important you select the right broker. You need to make sure they are credible and in a strong financial position. For more guidance, see our brokers page.
  • Trading on margin – While margin increases profit potential, it also increases risk. It is very easy to lose sight of the total exposure you have when using margin. $2000 worth of open positions using 5% margins mean exposure to $40,000 worth of contracts. You are effectively borrowing $38k from your broker. If markets move against you, losses can exceed deposits. An awareness of the total exposure is very important.

How To Start Trading CFDs

One of the selling points of trading with CFDs is how straightforward it is to get going. You’ll need to follow just five simple steps.

1. Choose A Market

There are thousands of individual markets to choose from, including currencies, commodities, plus interest rates and bonds. Try and opt for a market you have a good understanding of. This will help you react to market developments. Most online platforms and apps have a search function that makes this process quick and hassle-free.

2. Buy Or Sell

If you buy you go long. If you sell you go short. Bring up the trading ticket on your platform and you will be able to see the current price. The first price will be the bid (sell price). The second price will be the offer (buy price).

The price of your CFD is based on the price of the underlying instrument. If you have a reason to believe the market will increase, you should buy. If you believe it will decline you should sell.

3. Trade Size

You now need to select the size of CFDs you want to trade. With a CFD, you control the size of your investment. So although the price of the underlying asset will vary, you decide how much to invest. Brokers will however, have minimum margin requirements – or more simply, a minimum amount that is required in order for the trade to be opened. This will vary asset by asset. It will always be made clear however, as will the total value (or your exposure) of the trade.

Volatile assets such as cryptocurrency normally have higher margin requirements. So a position with exposure to $2000 worth of Bitcoin, might need margin of $1000 for example. A well traded stock however, may only need 5% margin. So a $2000 position on Facebook, may only require $100 of account funds.

4. Add Stops & Limits

This will help you secure profits and limit any losses. Most CFD strategies for beginners and experienced traders will employ the use of stop losses and/or limit orders. They tie in with your risk management strategy. Once you have defined your risk tolerance you can place a stop loss to automatically close a trade once the market hits a pre-determined level. This will help you minimise losses and keep your accounts in the black – leaving you to fight another day on subsequent trades.

A limit order will instruct your platform to close a trade at a price that is better than the current market level. If you opt for a trading bot they will use pre-programmed instructions like these to enter and exit trades in line with your trading plan. These are perfect for closing trades near resistance levels, without having to constantly monitor all positions.

5. Monitor & Close

Once you’ve placed your trade and stop or loss limits, your profits will shift along with the market price. You can view the market price in real time and you can add or close new trades. This can be done on most online platforms or through apps.

If your stop loss or limit order hasn’t been activated you can close it yourself. Simply select ‘close position’ from the positions window. You will be able to see your profit or loss almost instantly in your account balance.

Strategies

Choosing the right market is one hurdle, but without an effective strategy, your profits will be few and far between. You need to find a strategy that compliments your trading style. That means it plays to your strengths, such as technical analysis. It also means it needs to fit in with your risk tolerance and financial situation.

Below two popular and successful CFD trading strategies and tips have been outlined.

Breakout Strategy

This simply requires you identifying a key price level for a given security. When the price hits your key level, you buy or sell, dependent on the trend. The main thing to remember with breakout trading is to avoid any trades when the market isn’t providing clear signals.

If you can’t quite tell which direction the overall trend is moving in then give it a miss. This is where detailed technical analysis can help. Use charts to identify patterns that will give you the best chance of telling you where the trend is heading.

Contrarian Strategy

This is all about timing. Your plan rests on the knowledge that trends don’t last forever. If a stock’s price has been on the decline then you identify a point where you believe it’s near the end of the trend. Then you enter a buy position in anticipation of the trend turning in the other direction.

You can follow exactly the same procedure if the price is rising. You can short a stock that has been increasing in price when you think a sharp change is imminent. Both Wave Theory and a range of analytical tools will help you ascertain when those shifts are going to take place.

For further guidance, see our strategies page.

CFD Trading Tips

If you’re looking to really bolster your profits consider these tips from top traders. Learn from their mistakes and hopefully, you won’t run into the same expensive pitfalls.

Control Your Leverage

Leverage is your greatest asset when you’ve made the right trade. The temptation to increase your position sizes when you’re winning is difficult to resist. However, there is always a loss on the horizon.

You don’t want to be the trader that turns a small account into a huge account, only to end up back at square one. So, you need to be smart. Nobody wants the margin calls and the stress that come with big losses. As Paul Tudor Jones famously said, ‘Don’t focus on making money, focus on protecting what you have.’

Having said that, start small to begin with. Keep your exposure relatively low in comparison to your capital. It’s a good idea not to leverage more than 3 times your account size, particularly at the beginning.

As your capital grows and you iron out creases in your strategy, you can slowly increase your leverage.

Keep A Journal

A bit like a diary, but swap out descriptions of your crush for entry and exit points, price, position size and so on. This will be your bible when it comes to looking back and identifying mistakes. CFD trading journals are often overlooked, but their use can prove invaluable.

Hindsight is a powerful force, don’t waste it. You’ll be able to identify patterns, reflect on your trading emotions and streamline strategies. A thorough trading journal should include the following:

  • The instrument
  • The time you entered and exited the trade
  • Reasons for the trade, technical, news-based, etc.
  • Whether it was a profit or loss
  • A review of your trade performance (including whether you followed your trading rules)
  • What you learnt from the trade

It may sound time-consuming but it will allow you to constantly review and improve. You’ll make smarter and faster decisions, whilst those without are still scratching their heads wondering what they’ve been doing wrong for the last few weeks.

Use Stops

Used correctly you’ll be able to minimise your losses, keeping you in the game. Each trade you enter needs a crystal clear CFD stop. This is because emotions will inevitably run high and the temptation to hold on that little bit longer can be hard to resist. As William O’Neil correctly pointed out, ‘letting losses run is the most serious mistake made by most investors.’

So, define a CFD stop outside of market hours and stick to it religiously. This will also help you anticipate your maximum possible loss. You can then use the time you would be fighting an internal battle to research and prepare for the next trade.

Demo Accounts

When you’ve completed your research and you’ve finally got the capital to start trading, it can be hard to resist jumping in head first. However, the switched on day trader will test out his strategy with a demo account first.

Plenty of brokers offer these practice accounts. They’re funded with simulated money, making them the ideal place to make mistakes before your real money is on the line. Not only can you test your strategy and get familiar with CFD trading markets, but they’re also an effective way to try your broker’s trading platform. You can make sure it has all the charting and analysis tools your trading plan requires.

When you’re comfortable and seeing consistent results on your demo account, then upgrade to a live account.

Education

Nobody likes to hear it, but school isn’t over. The best traders will never stop learning. You need to keep abreast of market developments, whilst practising and perfecting new CFD trading strategies. Learning from successful traders will also help. To do all of this you’ll need to utilise a range of different resources. To name just a few:

Regional Differences

Taxes

Although you can trade CFDs all over the world, where you’re based and the market you’re trading in can throw an expensive spanner in the works. CFD trading in the USA will be different to that in the UK, Australia, India, South Africa, and Singapore.

This is mainly because of taxes. Different countries view CFDs differently. Some consider them a form of gambling activity and therefore free from tax. Some countries consider them taxable just like any other form of income.

The tax implications in the UK, for example, will see CFD trading fall under the capital gains tax requirements. Although you get a £10,100 annual exemption, any profits that exceed that will be taxed. This means you should keep a detailed record of transactions so you can make accurate calculations at the end of the tax year.

So, before you start trading, find out whether you’ll pay personal income tax, business tax, capital gains tax, or if you’re lucky, no tax. Once you know what type of tax obligation you will face you can incorporate that into your money management strategy.

For more detailed guidance, see our taxes page.

Final Word

Day trading CFDs can be comparatively less risky than other instruments. Having said that, it will still be challenging to craft and implement a consistently profitable strategy. If you want to be a successful CFD trader you will need to utilise the educational resources above and follow the tips mentioned. As successful trader Alex Hahn pointed out, If you master your thinking and your emotions, nothing can stop you.’ So, the ball is in your half of the court now, go and turn it into gold.

Money Management

Table Of Contents

What is Money Management?

Although you may think the title of Money Management is pretty clear and easy to implement – how to manage your money and invest wisely, it is slightly more than that. It is the educated process of how you save, invest, budget and spend domestic income. This can also fall on overseeing money usage for a business too.

Everyone in some form or another practices money management in day-to-day life, whether in their personal capacities or with investment management such as trading. Trading forex and CFDs successfully does require discipline. You’ll need a proper knowledge of the basic elements that are vital if you are expecting long-term gains from this industry.

Inexperience is possibly the main reason for traders losing money in forex and CFDs trading. Neglecting your money management principles as well as emotional trading increases risk and decreases your reward. As forex is extremely volatile at the best of times, therein lies an inherent risk, and having correct money management skills are essential when entering the markets.
Practice money management rules on a demo account or open a trading account and start implementing what you’ve learned.

Risk Management

When entering in to a forex or CFD trade, there needs to be a certain understanding, that you will enter risky situations and accept this as a prerequisite for leveraged trading. There are many risks when trading, however, there are various ways to reduce these risks.

While your profits are generally connected to the risks, here are a few principles:

  • Practice position sizing
  • Recognize your trading risks
  • Analyze and evaluate those risks
  • Establish solutions to reduce those risks
  • Apply and manage those solutions on a constant basis

Position sizing can be approached in a few ways, as simple to as complex as you choose, as long as it is best suited to your platform. This way you are able to easily manage both the losing trades and the winning ones. There are three models we can follow:

Fixed lot Size

Great way for beginners to start their trading careers. This means that traders will trade with the same position size, probably small. Lots can be changed during the trades according to how the account increases or decreases during the trading period. The account size is important when starting out, keep it small and use a leverage of 2:1, this way you can steadily grow potential profits over time.

Equity Percent

The idea behind Equity Percent is based on the size of your position based on the percentage change in equity. It is best to determine the percentage of equity for every position and this will determine and allow for growth of equity in relation to position size. One can always increase the percentage of equity used for every trade, but it is not without mention, that the higher the profit potential, the higher the risk.

What is a safe percent of equity to trade with?

It is often advised to trade with a smaller percentage of equity such as 1% or 2% that equates to 50:1 leverage per trade also allowing you to stay in your position for a longer period of time. Simply put, keep the size of your trades proportional to your equity, if you enter into losses, the position size is reduced preserving the account from depleting to a zero balance too rapidly. One can also reduce the size of the initial trade when you enter a losing streak to minimize the equity damage.

Remember that breaking even after losses takes more time than losing the same amount.

Advanced Equity percent with stop loss

The methodology behind this technique is to limit each trade to a set up a portion of your total account equity, this is often between 2-10%. This method differs from Fixed Ratio in that it is used in trading options and futures and helps you increase your exposure to the market while protecting your accumulated profits.
Practice money management rules on a demo account or open a trading account and start implementing what you’ve learned.

Guidelines for setting trades daily or weekly exposure levels

Let’s look at a simple example: if a trader’s trading balance is $1000 and he decides to risk only 2% of the balance ($20) in every trade. In case he trades a mini lot (10,000 units) of EUR/USD, then every pip is worth 1 USD. Thus, the trader should put a stop loss order if the price drops 20 pips. Losing 5 trades in a row will result in losing roughly $100.

Now, let’s say the same trader is ready to risk 10% of the budget on a single trade. He trades a standard lot of 100,000 units of EUR/USD, then every pip is worth 10 USD. In this case the trader should put a stop loss order if the price drops 10 pips (=$100) on the first trade. If he lost the first trade, the new stop loss target is 9 pips (=$90) which is 10% of the remaining balance of $900, and so on to 8,7, and 6 pips in following loosing trades. Losing 5 times in a row with this kind of exposure will result in total loss of $400.

Setting trades daily or weekly exposure levels

Number of Losing Trades (balance $1,000) 2% exposure 10% exposure
1 $980 $900
2 $960 $810
3 $940 $730
4 $920 $660
5 $900 $600

Same manner of exposure calculation can be scaled to include daily/weekly exposure levels. If, for example, the daily exposure level is 10% of the balance, then in the first example the trader would need to stop trading on the same day when he lost $100.

Risk and Reward ratios using Stop Loss

When you are ready to start trading you will open your live trading account on the appropriate platform and deposit your acceptable capital. Providing protection of your invested capital when forex or stocks move against you is essential and represents the basis of money management. Trading with a serious approach to money management can start with knowing a safe risk and reward ratio as well as implementing stops and trailing stops:

Stop loss:

This is the standard method for limiting loss on a trading account with a declining stock. Placing a stop loss order will set a value that will be based on the maximum loss that a trader is willing to absorb. When the last value drops below the set amount, the stop loss will be triggered and a market order is put in place so that the trade is haltered. The stop loss closes the position at the current market price and will prevent any accumulating losses.

Trailing stop:

In trailing stop there are more advantages when compared to the stop loss and it is a more flexible method of limiting losses. It allows traders to protect their account balance when the price of the instrument they have traded drops. An advantage of the trailing stop is that the moment a price increases, a ‘trailing’ feature will be set off, permitting any eventual safeguard and risk management to capital in your account. The main benefit of a trailing stop is that it allows protecting not only the trading balance, but the profits of the ongoing trade as well.

Risk and reward ratios

Another way you can increase protection of your invested capital is by knowing when to trade at a time of potentially profiting three times more than you will risk. Give yourself a 3:1 reward-to-risk ratio, based on this you should have a significantly greater chance of ending up in a positive return. The main idea is to set the target profit 3 times larger than the stop loss trigger, for instance setting a take profit order on 30 pips and stop loss on 10 pips is a good illustration of 3:1 reward-to-risk.

Keep your reward-to-risk ratio on a manageable scale here is an easy illustration of the reward-to-risk ratio to better understand it:

Reward-to-risk ratio

10 Trades Loss Win
1 $1,000
2 $3,000
3 $1,000
4 $3,000
5 $1,000
6 $3,000
7 $1,000
8 $3,000
9 $1,000
10 $3,000
TOTAL: $5,000 $15,000

Money Management tips with AvaTrade

Whether you are a day trader, swing trader or a scalper, money management is an essential restraint that needs to be learned and implemented per trade opened, no matter your trading style or strategy. Implement the money management techniques or you increase the risk of losing your money. These tips are basic and easy to follow when trading and in risk management:

You should never invest what you can’t afford to lose

First rule of thumb is never fund your account with money that you don’t have. Remember that if you can’t afford to absorb the losses of the invested capital then do not fund your account with money that you can afford to take a loss on. Trading is not a gamble, it needs to be entered into with educated decisions.

Stops and limits are meant to be implemented per position

As your broker we advise you to set stop loss orders. Take them as seriously as you do your investment, trading should be done with precision and not luck. You need a stop loss for every trade, it is your safety net that will protect you from big price moves.

When you profit

When you reach your target profit, close the trade and enjoy the gains from your trading. Withdrawing from AvaTrade is simple, fast and safe.

Open your account and enjoy all the benefits and trading advice from market professionals, test our services on your risk-free demo account.

Setting your stop loss and take profit orders

One of the most basic of trading principles are how to set your risk reward rations properly. This can be done by establishing where you can define your trade is going, how far the market will go in your favor. Having this number in mind sets the tone for organizing your Stop Loss (S/L) and Take Profit (T/P) orders.

As we mentioned, the traditional ratio in currency trading is 3:1 for the beginner, using a lesser risk reward ratio will become too risky. For the more experienced trader this can be increased to a minimum of 4:1 but never above 5:1.

Steps for setting up your S/L and T/P:

  • Write down your target profit in pips. This number can be either arbitrary or derived from forecastable price levels and current market price.
  • Take the number from previous step and divide it by the reward-to-risk ratio to calculate the maximum allowed negative price movement.
  • Now you are ready to set up your S/L and T/P orders, by taking the numbers of your target profit and tolerable risk values, and calculating the distance from the current market price (in pips) for both the risk and reward value. From these two numbers you set them up as your Stop Loss and Take Profit levels.

To illustrate the aforementioned rules here’s an example:

The current price EUR/USD is trading at is 1.02660.

We assume that the market will trend upwards, and we want to ride the trend, since we believe that the market will go to 1.02759 at a minimum.

So we would take our target price of 1.02760 and subtract the current market price of 1.02660:

1.02760 – 1.02660 = 100 (pips)

To calculate the value in pips of the risk factor based on a 3:1 reward/risk ratio we divide the total number of pips (100) by the reward ratio (3) = 33.33 pip (risk)

We have easily worked out the risk and reward targets and now we set the S/l and T/P levels

Finally, to calculate the final stage take the current market price and subtract from it the risk value. Then add the reward value to the current market price and the final figures will be the S/L and T/P.

1.02660– 0.00033 = 1.02627 S/L

1.02660 + 0.00100 = 1.02760 T/P

Learn and Trade with AvaTrade

AvaTrade is a pioneer in online trading and customer service, offering you a wide selection on all aspects of forex trading education. To learn more about trading and understanding the essentials, get in touch with our service team today.

We recommend you to visit our trading for beginners section for more articles on how to trade Forex and CFDs.

What is CFD trading and how does it work?

Trading contracts for difference (CFDs) is a way of speculating on financial markets that doesn’t require the buying and selling of any underlying assets. Find out everything you need to know to understand CFD trading, from what it is and how it works to short trades, leverage and hedging.

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What is CFD trading?

CFD trading is defined as ‘the buying and selling of CFDs’, with ‘CFD’ meaning ‘contract for difference’. CFDs are a derivative product because they enable you to speculate on financial markets such as shares, forex, indices and commodities without having to take ownership of the underlying assets.

Instead, when you trade a CFD, you are agreeing to exchange the difference in the price of an asset from the point at which the contract is opened to when it is closed. One of the main benefits of CFD trading is that you can speculate on price movements in either direction, with the profit or loss you make dependent on the extent to which your forecast is correct.

The sections that follow explain some of the main features and uses of contracts for difference:

Short and long CFD trading explained

CFD trading enables you to speculate on price movements in either direction. So while you can mimic a traditional trade that profits as a market rises in price, you can also open a CFD position that will profit as the underlying market decreases in price. This is referred to as selling or ‘going short’, as opposed to buying or ‘going long’.

If you think Apple shares are going to fall in price, for example, you could sell a share CFD on the company. You’ll still exchange the difference in price between when your position is opened and when it is closed, but will earn a profit if the shares drop in price and a loss if they increase in price.

With both long and short trades, profits and losses will be realised once the position is closed.

Leverage in CFD trading explained

CFD trading is leveraged, which means you can gain exposure to a large position without having to commit the full cost at the outset. Say you wanted to open a position equivalent to 500 Apple shares. With a standard trade, that would mean paying the full cost of the shares upfront. With a contract for difference, on the other hand, you might only have to put up 5% of the cost.

While leverage enables you to spread your capital further, it is important to keep in mind that your profit or loss will still be calculated on the full size of your position. In our example, that would be the difference in the price of 500 Apple shares from the point you opened the trade to the point you closed it. That means both profits and losses can be hugely magnified compared to your outlay, and that losses can exceed deposits. For this reason, it is important to pay attention to the leverage ratio and make sure that you are trading within your means.

Margin explained

Leveraged trading is sometimes referred to as ‘trading on margin’ because the funds required to open and maintain a position – the ‘margin’ – represent only a fraction of its total size.

When trading CFDs, there are two types of margin. A deposit margin is required to open a position, while a maintenance margin may be required if your trade gets close to incurring losses that the deposit margin – and any additional funds in your account – will not cover. If this happens, you may get a margin call from your provider asking you to top up the funds in your account. If you don’t add sufficient funds, the position may be closed and any losses incurred will be realised.

Hedging with CFDs explained

CFDs can also be used to hedge against losses in an existing portfolio.

For example, if you believed that some ABC Limited shares in your portfolio could suffer a short-term dip in value as a result of a disappointing earnings report, you could offset some of the potential loss by going short on the market through a CFD trade. If you did decide to hedge your risk in this way, any drop in the value of the ABC Limited shares in your portfolio would be offset by a gain in your short CFD trade.

How do CFDs work?

Now you understand what contracts for difference are, it’s time to take a look at how they work. Here we explain four of the key concepts behind CFD trading: spreads, deal sizes, durations and profit/loss.

Spread and commission

CFD prices are quoted in two prices: the buy price and the sell price.

  • The sell price (or bid price) is the price at which you can open a short CFD
  • The buy price (or offer price) is the price at which you can open a long CFD

Sell prices will always be slightly lower than the current market price, and buy prices will be slightly higher. The difference between the two prices is referred to as the spread.

Most of the time, the cost to open a CFD position is covered in the spread: meaning that buy and sell prices will be adjusted to reflect the cost of making the trade.

The exception to this is our share CFDs, which are not charged via the spread. Instead, our buy and sell prices match the price of the underlying market and the charge for opening a share CFD position is commission-based. By using commission, the act of speculating on share prices with a CFD is closer to buying and selling shares in the market.

Deal size

CFDs are traded in standardised contracts (lots). The size of an individual contract varies depending on the underlying asset being traded, often mimicking how that asset is traded on the market.

Silver, for example, is traded on commodity exchanges in lots of 5000 troy ounces, and its equivalent contract for difference also has a value of 5000 troy ounces. For share CFDs, the contract size is usually representative of one share in the company you are trading. To open a position that mimics buying 500 shares of HSBC, you’d buy 500 HSBC CFD contracts.

This is another way in which CFD trading is more similar to traditional trading than other derivatives, such as options.

Duration

Most CFD trades have no fixed expiry – unlike options. Instead, a position is closed by placing a trade in the opposite direction to the one that opened it. A buy position of 500 gold contracts, for instance, would be closed by selling 500 gold contracts.

If you keep a daily CFD position open past the daily cut-off time (typically 10pm UK time, although this may vary for international markets), you’ll be charged an overnight funding charge. The cost reflects the cost of the capital your provider has in effect lent you in order to open a leveraged trade.

This isn’t always the case though, with the main exception being a forward contract. A forward contract has an expiry date at some point in the future, and has all overnight funding charges already included in the spread.

Profit and loss

To calculate the profit or loss earned from a CFD trade, you multiply the deal size of the position (total number of contracts) by the value of each contract (expressed per point of movement). You then multiply that figure by the difference in points between the price when you opened the contract and when you closed it.

Profit or loss
=
(no. of contracts x value of each contract)
x (closing price – opening price)

For a full calculation of the profit or loss from a trade, you’d also subtract any charges or fees you paid. These could be overnight funding charges, commission or guaranteed stop fees.

Say, for instance, that you buy 50 FTSE 100 contracts when the buy price is 7500.0. A single FTSE 100 contract is equal to a $10 per point, so for each point of upward movement you would make $500 and for each point of downward movement you would lose $500 (50 contracts multiplied by $10).

If you sell when the FTSE 100 is trading at 7505.0, your profit would be $2500

2500 = (50 x 10) x (7505.0 – 7500.0)

If you sell when the FTSE 100 is trading at 7497.0, your loss would be $1500

-1500 = (50 x 10) x (7497.0 – 7500.0)

Can I trade CFDs without leverage?

Some providers allow you to trade CFDs without leverage. With IG, however, all CFD trades are leveraged. The amount of leverage offered depends on various factors including the volatility and liquidity of the underlying market, as well as the law in the country in which you are trading.

How do I use CFDs for hedging?

The way to use CFDs for hedging is by opening a position that will become profitable if one of your other positions begins to incur a loss. An example of this would be taking out a short position on a market that tracks the price of an asset you own. Any drop in the value of your asset would then be offset by the profit from your CFD trade.

Say, for example, you hold a number of shares in Apple but believe these shares may fall in value in the future. You could go short on Apple via a share CFD. If you are correct and your Apple shares fall in value, then the profit from your short CFD trade will offset this loss.

What is the difference between CFDs and futures?

When you trade CFDs (contracts for difference), you buy a certain number of contracts on a market if you expect it to rise, and sell them if you expect it to fall. The change in the value of your position reflects movements in the underlying market. With CFDs, you can close your position any time when the market is open.

Futures, on the other hand, are contracts that require you to trade a financial instrument in the future. Unlike CFDs, they specify a fixed date and price for this transaction – which can involve taking physical ownership of the underlying asset on this date – and must be purchased via an exchange. The value of a futures contract depends as much on market sentiment about the future price of the asset as current movements in the underlying market.

It is worth keeping in mind that with an IG CFD trading account, you can speculate on the price of futures contracts without having to buy the contracts themselves.

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The risks of loss from investing in CFDs can be substantial and the value of your investments may fluctuate. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how this product works, and whether you can afford to take the high risk of losing your money.

CFD Accounts provided by IG International Limited. IG International Limited is licensed to conduct investment business and digital asset business by the Bermuda Monetary Authority and is registered in Bermuda under No. 54814.

The information on this site is not directed at residents of the United States and is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

IG International Limited is part of the IG Group and its ultimate parent company is IG Group Holdings Plc. IG International Limited receives services from other members of the IG Group including IG Markets Limited.

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