CFD Trading for beginners Guide
CFD trading for beginners represents an interesting financial field when it comes to investment. In fact, CFD is a famous financial instrument. It is basically a type of derivative. However, derivatives are financial contracts that derive their value from an underlying asset. And it is an arrangement between two parties that can be traded on an exchange market or over-the-counter (OTC) market.
Therefore, CFD consists of a contract between a buyer and a seller, in which the buyer must pay the seller the difference between the opening value of an asset and the closing value. In this course, we will explain how CFD trading Strategy works, and how to trade such instruments. And we will give some examples.
CFD Trading for Beginners FAQ
What is Contract for Differences (CFDs)?
CFD trading for beginners can assist traders to learn the basic techniques that every trader should know. So let’s start by understanding the meaning of CFD. Indeed, CFD or contract for difference is a kind of derivative contract that allows traders and investors to benefit from price movement without holding an underlying asset. Therefore, it derives its value from the performance of the underlying asset in the market. It is a contract that stipulates that the buyer must pay an amount of money to the seller which involves the difference in settlement price between the opening price and the closing price of the asset. So, a CFD contract value doesn’t take into account the asset’s underlying value, only the change in price between entry and exit.
This agreement between the buyer and the broker allows its holder to invest and trade, in the short term, in various financial markets including forex trading for dummies, shares, indices, stocks, cryptocurrencies, and commodities. Therefore, with CFDs, you just buy or sell a contract depending on what you believe will happen in the asset’s price. And they ensure that even with small investments there is a chance of earning yields equal to the underlying asset. trad
How to start CFD trading ?
CFD trading for beginners implies understanding some fundamental rules in order to comprehend the overall market. So, when you decide to trade contracts for difference (CFDs) as beginners, it means that you will engage in a contract between you and the broker. This engagement takes place as follows:
1. Select an asset presented by the broker as a CFD. It can be an index, stock, or any other instrument that the broker possesses in its selection.
2. Open a position and puts your own parameters. Such as the amount invested, leverage, position (short or long), and other parameters according to the broker.
3. The two parties agree to engage in a contract: The buyer agrees to pay an amount of money to the broker in the counterparty receives the contract, as well as the seller (broker), agrees to sell the contract. This is why we call it an agreement. This amount of money represents the open price for the position which will be agreed upon by the two parties. and can be there also other fees like overnight fees.
4. Once the trader opens the position, it remains like it is until he/she decides when to close it. It can also close automatically when it reaches the SL or TP level. Or when the contract expires.
5. If the position ends at a gain, then the broker pays the investor. If not means it closes in loss, in this case, the broker provides the trader with the difference.
CFD Trading examples
The CFD’s owner trades price movement without holding the underlying asset which allows him/her to avoid some drawbacks and costs of standard trading. It is an advanced trading system used generally by professional traders. However, CFD trading beginners should be aware of this information. As we said there is no delivery of physical goods or securities with CFDs. A CFD trader will never hold the underlying asset but he/she will buy or sell a number of units for this asset and receives instead an income based on the price change of that asset. For instance, rather than buy or sell physical silver, you can simply assume whether the price of silver will rise or fall.
In fact, CFD enables traders to speculate on short-term price movement. This means traders can invest not only when the market goes up, but also when it goes down. However, traders will make assumptions about whether or not the price of the underlying asset will increase or decrease.
If the CFD’s buyers think that the price of the asset will rise, then they will go long, which means buying a number of CFD contracts (also named units). The net difference between the buy price and the sell price is netted together. And this net difference, which represents the profit from the trades, is settled via the brokerage account of the trader. Besides, if they think that the price will decline, then they will offer the CFD for sale.
Moreover, when traders open a CFD position, they choose the number of contracts they want to trade (number of units). And their profit will rise with each point the market move in their favor. This means they earn multiple the number of CFD units they have bought or sold. However, for every point the price shifts against you, you will record a loss. You can calculate your profit and loss using the following formula:
Profit & loss = nb of CFDs × (closing price – opening price)
Note: You have also to subtract any fees or charges you paid to obtain your profit or loss.
There are no fixed expiration dates on CFDs, thus in order to close your current position, you have to set an offsetting trade in the other direction. For instance, if you bought 600 contracts in the beginning, then to close your position you have to sell them.
For Australia, CFDs are permitted currently. However, the Australian Securities and investment commission (ASIC) has declared some changes in the issue and the distribution of these contracts to retail clients. The goal of ASIC is to boost consumer protection by decreasing CFD leverage available to retail customers. This order took effect on the 29th of March 2021.
What are the costs ?
In effect, there are some costs that CFD trading beginners should know in order to trade profitably:
Every contract has two prices a purchase price (the ask) and a sale price (the bid), which are respectively almost higher and lower than the value of the underlying instrument. The difference between these two prices named the forex spread. The spread reflects how much will cost you to make a trade. Therefore when you buy a CFD contract you must pay the spread. You enter a long position using the offer price, whilst you enter a short position using the bid price.
- Holding costs
Once the trading day ends, which differs in each country, any open positions in your account can be subject to a charge named a”holding cost”. This kind of cost can be positive or negative depending on the holding rate applied and the direction of your position.
When trading share CFDs, you must pay a separate commission charge.
Advantages and disadvantages
- CFDs are leveraged products. This means that CFD trading beginners, only need to put down a small percentage of the underlying value to trade the hole trade. This is named “trading on margin”. The CFDs generally provide higher leverage than other traditional instruments. Therefore high leverage can boost the traders’ likely profit. Lower margin requirements signify that the potential returns are greater overall. You should keep in mind also that CFDs can magnify your losses.
- Access to the global market: CFD brokers offer products all over the world markets. So traders have the opportunity to trade CFD on a wide range of world markets.
- Allow traders to go short or long without any condition.
- The CFDs can be shorted at any time without any additional cost.
- To trade CFD you must pay the spread on entry and exit positions. So this will be potentially difficult for CFD trading beginners to make small profits. The spread lessen winning trades by a small amount of money, compared to the underlying instrument, and boosts losses by a small amount. Thus, CFDs prune the profits of traders through the spread costs.
- Trading CFD can be risky, as there are liquidity risks and margins you have to maintain. so you need to monitor your position carefully and place a risk management strategy.
Contracts for difference are derivative contracts that allow CFD trading beginners to sell and exit positions without holding the underlying instrument. It allows traders to access global markets. Besides, there are no day trading rules and can be shorted at any time without any additional costs. Moreover, traders have to pay the spread every time entering or exiting a trade similar to the spread betting Strategy.