CFD TRADING FOR BEGINNERS –
WHY TRADE CFDS?
The term CFD stands for Contract For Difference. This is a contract to exchange the difference in value of a financial instrument (the underlying market) between the time at which the contract is opened and the time it is closed.
Trading with CFDs can give you a range of advantages, including:
- The ability to go long or short
- The ability to hedge
- Flexible contract sizes
- Trading on margin
CFDs are a form of leveraged trading, which means that you can gain exposure to a financial instrument while putting down just a proportion of the full contract value. You should always bear in mind, however, that leveraged trading can lead to rapid losses and you can lose more than your initial deposit. Please ensure you understand the risks involved.
What this means is that you select the market you want to trade but rather than making the full physical purchase (or sale) you open a CFD with us instead. This contract will replicate the profit and loss of your intended purchase (or sale).
CFDs are fast growing in popularity as a flexible alternative to traditional share trading, giving you a greater degree of leverage on your investment capital.
How a CFD works
Say you want to buy 1000 shares in BP. You could buy these shares through a stockbroker, paying the full value of the shares (1000 x the current market offer price of BP) plus a commission to the stockbroker.
Alternatively, with Intertrader you could buy 1000 CFDs in BP at the live market price. This would give you exactly the same exposure, but to open this contract you would only have to supply a margin deposit to cover any potential downside, and pay a small commission.
Selling shares through a CFD provider is easy. You just open your contract to go short rather than long, at our bid price. For this reason CFDs are often used by clients who want to hedge an existing investment portfolio.
Although originally devised for equity trading, CFDs are also used to trade indices, forex, energies, metals, commodities and more. Our CFD service covers a wide range of asset classes matching the scope of our spread betting service. As with our equity markets, the charge for all our non-equity contracts is built into the dealing spread.
A CFD is a flexible investment vehicle. For contracts that don’t have an expiry, you decide exactly when you want to close your position and realise your profit or loss.
You trade in the currency of the underlying market (e.g. US dollar for US equities) and your profit or loss is converted into the base currency of your account when your position is closed.
CFD trading benefits
The ability to go short or long with CFDs makes them a popular option for traders who want to hedge against an existing investment portfolio. For example, if you have a long position on a stock that is accruing losses, you can open a position in the opposite position using a short CFD.
The ability to trade in both bull and bear markets adds flexibility to your CFD trading strategy and allows you to forecast price movements that coincide with the underlying fundamentals (which can fluctuate in both positive and negative directions).
CFDs give you a flexible variety of available trade sizes. It is generally recommended that newer traders use smaller lot sizes until they have developed a successful trading strategy that makes gains over time. More experienced investors can choose to put more money at risk so that they do not feel limited in the way their trades are structured.
As you are trading on margin, you are only required to deposit a portion of the actual trade size for each CFD transaction. For example, say you have a CFD share trade worth £1000 (either in a short or long position). If your margin requirement is 20%, this would mean you only need £200 to open the position.
The positive side of this is that you receive all of the gains made for the entire trade (not only 20% of the gained value). The downside, of course, is that you will also be fully responsible for any losses accrued. So if the £1000 trade moved 5% in an adverse direction, you would lose 5% of the full value of your initial position.
Margin trading is one of the most important aspects of CFD strategy. To get started with CFDs, you can build your understanding through research, or by opening a demo account, through which you can make risk-free trades using virtual currency.