Contracts for difference (CFDs) have become such a popular form of trading on markets that more people than ever are using the method to great effect. Whether you are a DIY novice, someone who is switching from another form of trading or a professional who is late to the party but eager to find out what the fuss is about, there are some basics that you will need to learn in order to place a CFD trade.
Traders can use thousands of different instruments in CFD trading, and the options offered by leveraged trading, 24-hour dealing opportunities and the ability to trade on falling markets all add to the appeal of using CFDs.
Some areas of operations in trading on global markets can be complicated, and different financial instruments can offer complex outcomes. CFD trading is essentially a series of steps that take place in a logical order, and the bottom line comes down to a choice made regarding the direction that the value of an asset will take.
Choosing a market
CFDs are available on thousands of individual markets. This means that shares, indices, commodities, forex pairs and even interest rates set by central banks can be the basis for a CFD trade. Major global markets that are accessible for CFD traders include the UK, Europe, Asia, Australia and New Zealand.
The main issue to remember when starting out in the world of CFD trading is that the whole process is predicated on the changing value of an underlying asset that is never actually bought or sold in the trade. This can have practical and positive tax implications and is much more straightforward in comparison with other “derivative” forms of trading such as futures and options.
Choosing a market on which to trade offers virtually unlimited possibilities; Traders can make decisions based on some form of personal experience or knowledge by using various forms of chart analysis or an “emotionless’” approach where all assets are almost anonymous ciphers.
Deciding to go long or go short
After choosing a market and doing some research as to where prices stand and how they have been behaving over certain time frames, the decision to go long or short is the next basic step. CFD markets have two prices: the selling price (the bid) and the buy price (the offer). The spread is the term for the difference between the two.
Believing that the price of the underlying asset or selected market will rise means that the trader will take a long position, while if the price is likely to fall, then the trader will take a short position.
Leverage
Selecting the trade size does not totally depend on the funds or capital that traders have because CFDs are a leveraged product. This means that only a small percentage of the overall trade value is necessary to make a trade in a process known as the margin. In general terms, the larger the trade, the larger the margin needed.
While using leverage effectively can lead to impressive results, there is also an added level of risk. However, CFD trading comes with various checks and balances that work as a risk management strategy, and this is a very important part of the learning curve for anyone new to this style of trading.
Stop and limit orders
Risk management is an essential part of any trading plan, but for leveraged products such as CFDs, it is even more key to overall success. Of course, not every trade will be successful, so knowing how to limit losses and get out of trades at the right time is vital.
A widely used technique is a stop loss, which automatically closes a trade when that particular market hits a predetermined level. This is basically an instruction made upon taking out the trade and setting a point where the platform used closes an open position. It is set at a price below the current market level and triggers when a trade is already making a loss, but it cuts off at a certain point to minimise risk within set parameters.
Monitoring and closing your trade
CFDs are still relative newcomers on the trading scene, which is why some people are still wary of them and look back to so-called “mature” products such as futures. However, the fast-moving pace of CFD trading is perfectly suited to the real-time data available to all via new technology. This essentially means that anyone can be their own broker by using an Internet-based platform to make trades.
Being able to see profit/loss updates in real time means that traders can close and exit their trades simply by clicking a button on a screen. This ability to monitor trades has all but revolutionised the way that markets work and how accessible that they are today. The fact that traders can access reputable platforms 24/7 from apps on smartphones or tablets makes CFDs even more attractive to a new breed of investors interested in using cutting-edge methods.
While older forms of trading based on traditional asset owning trades are far from in their death throes, there is no doubt that CFDs have breathed new life into the markets and brought in a diverse set of new traders to become part of the action.