Contract for Difference (CFD)

Chapter 1: What is CFD?

CFD is a derivative instrument that allows investors to participate in trading stocks, assets or other financial products without actually owning the underlying stock or product.

The way CFD trading works is very simple. For example, you are optimistic that the price of Brent crude oil may rise, so you buy Brent crude oil price CFD (assuming the current price is $50 per barrel). When the contract expires, the CFD seller will pay you the proceeds of the increase in price. For example, if the oil price rises to $55 a barrel, the seller will have to pay you $5 per CFD.

Before describing how to trade CFD in detail, let's take a look at the current tradable products.

Chapter 2: What CFDs are available for trading?

That's a good question. CFD applies to a wide range of financial assets or products, the most common of which are:

Commodity such as: energy products (oil, natural gas); Industrial metals (copper, aluminum); Precious metals (silver, gold) and agricultural products (coffee, wheat).

Stock the share prices of listed companies in most of the world's stock indices can be traded in CDF.

Index both domestic and international stock index levels can be traded, such as the FTSE 100 in London and the S & P 500 in New York.

Currency, refers to the exchange rate level, e.g., USD/GBP. It is usually expressed in currency codes, such as GBP/USD for the pound and dollar, EUR/JPY for the euro and yen.

There are numerous investment varieties, and other financial products (such as exchange-traded funds) can also be used for CFD trading. In simple terms, any product that has an index or price level that reflects its trading volume can be CFD traded.

Trading Tip 1: Understand the Market

This is the golden rule that any good trader should follow. Before investing or buying financial products, it is especially important to understand the market you are entering. Trading a CFD means that you must understand the "underlying" market for that CFD. You can keep up with recent trading and developments in the market by viewing charts (all available for free by Bloomberg, Reuters, Financial Times and Google Finance) and reading financial news.

Chapter 3: How does CFD trading work?

Suppose you decide to choose CFD as the best way to enter a particular market, what should you do first?

Choose a trusted trader. Many financial companies offer CFD services, and today most of the work can be done using online trading platforms.

Before you start trading, you need to open a margin account. "Margin" is like your trading deposit. In addition to this, the broker also allows you to use a certain amount of "leverage" or financing.

The effect of leverage is actually to allow you to borrow money from a brokerage firm to increase your purchases, which helps to improve your investment capacity (see Exercise 1 below for details), but it also carries additional risk.

When you buy CFD, you are essentially betting that the price of the asset will go up or down. This is called building a warehouse. If you bet on the price going up, you are "going long". Conversely, if you bet on a price drop, you are "short".

Exercise 1: The Benefits of Leverage

Phronimos Group take a look at one of the hottest U. S. Stocks-Apple Inc.

You thought Apple's stock price would go up, so you decided to go long.

Exercise 2: Make good use of stops

Now let's look at index trading, which is currently the most common form of CFD trading.

Let's say you 've been working on it and think the FTSE 100 index is doing well this month, so you decide to go long.

Exercise 3: Short

The only difference here is that you are betting that the price of an asset will fall. To paraphrase a market jargon, you are buying long and selling short. This time, let's say you're selling gold.

Build a warehouse: The broker advises you to open your position at $103 on September 9 and you decide to buy 100 CFD. For full margin, you need to deposit (100 x 103) = $10,300, plus a commission as a transaction cost, which may be 0.1%, or $10.30. There may be other costs, such as overnight fees. Be sure to look carefully at the full cost of the transaction before you buy.

As mentioned above, if you use the full amount, the amount of deposit you need to pay is huge. But if the broker agrees to charge only 10% margin, you only need to deposit $1,030. If it is 5%, you only need to deposit $515.

Centered positions on September 14, you decided to take a profit to close your position because the stock price had risen to $111.77, or $8.77 per share, for a total profit of $877. Of course, you also need to pay a commission when you close your position.

Trading Tip 2: How to follow the news?

When investing in any single stock, you need to pay close attention to the latest developments in the media about the company, such as the company's quarterly profit report, annual shareholder meeting, new product development or board changes. The above news and other more information can be used as a reference for future stock price performance.

Build a warehouse: The broker suggested that you open a position with US $6,807.7 on September 27. You decided to buy 10 CFD. If it is full margin, you need to pay US $68,077. If it is 5%, you need to pay (10 x 6,807.7 x 0.005) = 340.39 USD

Centered positions: The FTSE 100 rose 41.7 points to $6,849.4 the next day. Your 10 CFD's are now worth $68,494 and are profitable (68,494 - 68,077) = $417.

Warning: You choose to go long and of course you want the share price to rise. However, if the index actually falls by the same amount, I .e. to $6,766, your margin will not be enough to cover the loss. At this point, the broker will issue a "margin call" to you, which means that you either pay the margin or close out the position and pay the amount of the loss.

To avoid excessive margin pressure, you can set a "stop loss", which means you can set the level of automatic closing, especially when the market moves in the opposite direction.

Set Stop Loss Position: You still buy 10 CFD at 5% margin and open a position at $6,807.7. The deposit you need to pay is still $340.39 (ibid.). But this time, you set a stop loss of 6,773 on FTSE, which means you keep the potential loss at $340 (just within the margin range) and close the position out.

Trading Tip 3: Reduce Losses

Do not continue to hold a trade that has already lost money because your intuition believes that a trade will reverse the trend. Never add margin to a losing trade. No one wants to make mistakes, but if they are wrong, please accept them and move on.

Build a warehouse: You chose to sell 10 copies of Comex gold futures CFD on September 26 at a price of US $1,339. A 5% deposit is required (10 x 1339 x 0.005) = $66.95.

Centered positions: You held your position until October 4, and the price fell to $1,267. This is a good deal, you have earned (13,390 - 12,670) = $720.

Trading Tip 4:

The asset classes involved in each of the above exercises are different and it is important to keep this in mind when trading. Don't stick too hard on a particular deal. Diversify your portfolio to avoid a single mistake that can lead to a loss of money. Understand the risks you face and never take more risks than you can afford.