Trading CFDs is one of the ways to participate in the capital markets by investing in different asset types. Here, we take an in-depth look into CFDs, how they work, and how you can trade them in Australia.
A Contract for Differences (CFD) is a legal agreement between two parties to trade based on the difference between the opening and closing prices of specific financial instruments. In simple terms, if the closing price of a CFD contract is higher than its opening price, the seller pays the buyer the difference, and the buyer makes a profit. The inverse is also true. If the closing price of a CFD is lower than its opening price, the buyer pays the difference into the seller’s account with a loss.
This nature of CFDs makes them unique vehicles for trading both bull and bear markets. Since prices fluctuate wildly during both market cycles, you can use CFDs to take advantage of price differences in underlying markets and potentially create market opportunities from your predictions.
Since CFD markets have high liquidity, they can be considered as instruments for short-term traders looking to get into and out of different trade positions fast within a given time frame.
Also, CFDs trade over the counter through brokers and market makers. The two-party nature of CFDs makes it impossible to trade on major exchanges and you can only trade CFDs with one counterparty, your broker.
CFDs allow you to trade many assets and securities. Here are some common examples:
Here are some standard features across all CFDs:
1. CFDs Are Derivatives
In the context of CFDs, derivatives allow you to speculate on the price movements of actual assets rather than purchase them. As we’ll discuss shortly, the derivative nature of CFDs is a significant perk. You can create trading opportunities from an underlying asset without owning it.
2. CFDs Are Leveraged
Leverage is a feature that allows you to trade CFDs without paying the total cost of your position upfront. Your broker enables you to trade on margin – the minimum capital required to open a CFD position.
3. CFDs Trade Over the Counter (OTC)
CFDs trades are executed between only you and your broker. There are no third parties involved. For this reason, you won’t find CFDs on any exchange. CFD contracts, by nature, support only two participants: the buyer and the seller.
Here are some benefits of trading CFDs:
Let’s define some standard terms you’ll encounter while trading CFDs.
Margin is the minimum capital required to open a CFD position with your broker. Your broker allows you to borrow funds against your margin to increase your market exposure. This facility, also known as leverage, can potentially magnify your returns if used correctly.
Your broker holds your margin as collateral to keep your positions open during your trading cycles. You may need to deposit more funds into your brokerage account to open more CFD positions.
Each broker has different margin requirements, depending on your jurisdiction and internal policies. Also, different trading instruments could have different margin rates, depending on the liquidity and volatility of the underlying assets.
Click the link to learn more about margin trading in Australia.
Leverage increases your exposure to an underlying market. Essentially, leverage is a loan your broker gives you to cover the full value once you make the minimum deposit needed in your account
Most brokers present leverage as a ratio, such as up to 30:1 in Australia.
Here’s a quick example of how this works, for illustration purposes only:
With Vantage, you can trade any of the major Foreign Exchange pairs with the leverage up to 30:1. This equals a margin percentage of 3.33%.
Let’s say that you want to open a long AUD/USD position with a notional value of $1,000.
Without any leverage, you’d have to pay the total cost of the trade and purchase $1,000 to open this position.
With leverage, the initial amount needed to fund this position would be $1,000 x 3.33% = $33.3.
So, if the price of AUD/USD goes up by 10%, you make the same profit as the entire trade, but at a considerably reduced cost.
However, you also need to consider that leverage increases your exposure which can magnify not only your profits but losses as well.
Margin and leverage go hand in hand with all CFD trades. You need margin to trade using leverage, and leverage uses margin to give you the power to control more significant positions with limited capital.
Since CFDs take advantage of price changes in the underlying markets, you have the opportunity to create trading opportunities from both long trades and short trades.
When you take a long position in a trade, you have purchased an asset to sell later when the price goes up. “Going long” and “buying” are the interchangeable terms most day traders use to take such a position.
Some trading platforms have also adopted these terms. Some have “buy” on their trade entry buttons while others have “long”.
Taking a short position can be quite confusing to new traders. Unlike long security positions where you buy an actual asset, short trades sell assets before buying them in the hope prices fall so you can sell to another trader.
“Sell” and Short” are two common ways to describe a selling position. Trading platforms also use both terms interchangeably.
Trading CFDs is a common risk management strategy for mitigating any losses in your existing trading portfolio.
CFDs are useful as a hedging tool as you only need margin and leverage to replicate a short position to hedge against loss from a long position.
Trading CFDs incur some costs. They include:
All CFDs come with two quotes: The sell (bid) and buy (offer) prices. The bid price is the price at which you can short a CFD contract. On the other hand, the offer price is what it costs to open a long CFD position.
The bid price is usually slightly lower than the market price of the underlying asset and the offer price is slightly higher.
The spread is the difference between these two prices.
In most cases, the spread covers the cost of the trade. The only exception is stock/share CFDs where the sell and buy prices match the underlying market. Instead, you pay commissions to trade them. Commission rates vary across brokers but in most cases an average of about 0.1%.
That makes the experience of trading share CFDs as close as possible to actual share trading.
Vantage now offers $0 commission trading on all US Share CFDs including popular products such as Apple (AAPL), Tesla (TSLA), Microsoft (MSFT), Netflix (NFLX), Alphabet (GOOG) and more.
If you’d like to keep your position open overnight, you’ll pay your broker an overnight financing cost to keep your position open. Overnight positions are considered investments, and your broker will charge you interest for every night your position remains open.
At Vantage, no commission fees are charged when you trade Gold CFDs****. Other fees or changes may apply.
**** Gold CFDs including XAUUSD, XAUAUD, XAUEUR
Some brokers offer services like guaranteed stops charged at small premiums. That way, your broker guarantees you protection for all your positions against slippage and sudden losses. You may pay other fees for services like:
To trade CFDs, you can follow these steps:
First, open a trading account with a broker of your choice. You can follow the procedure found on their website and you’ll be up and running in a few minutes.
Most brokers ask for your identification documents and proof of address to verify your account. Once verified, you can access all the full features of your trading account.
There are multiple ways you can fund your account, depending on the funding options offered by your broker. You can even fund in currencies that are not your local currency, if you prefer. For example, one way is to connect your credit/debit card directly to your trading account to fund the account.
If you’re still unsure, you can open a demo account in a risk-free environment that lets you trade without loss.
A strategy is the backbone of successful trading activities. A trading plan helps you determine:
A trading plan helps you make calculated decisions that protect you from wiping out your account. With a plan, you make better decisions on your desired returns, acceptable loss and risk mitigation strategies that protect your capital.
CFD markets are wide, and some brokers offer thousands of markets to choose from. You can opt for:
Choose a market you’re familiar with, or have sufficient knowledge about. That will be able to help you make better trading decisions.
Once you’ve chosen your markets, decide whether you want to go long or short. CFDs give you the opportunities to access both options.
There are several ways to monitor your position. You broker can:
You can also monitor your positions directly from your trading platform.
Once your position moves in your favour, you can use the “close” button to exit the trade. You can also use this button to exit any losing trades and take an acceptable loss. To close a long position sells your CFD and closing a short position buys a CFD.
Your broker will deduct their fees from your return on investment or your capital if you incurred a loss.
CFDs can be a go-to product for traders to trade, especially if you’re hedging your portfolio position or have access to limited capital. You enjoy features like leverage, minimal fees, and access to multiple different asset classes. You can go long or short, depending on your strategy, and trade thousands of markets. However, be wary of leverage. Using it poorly can lead to losses that exceed your capital.
Access CFD markets on forex, commodities, indices, shares/stocks and more, at low cost.
Disclaimer: Vantage Global Prime Pty Ltd is authorised and regulated by the Australian Securities & Investments Commission (ASIC) AFSL no. 428901. The information is generic and does not constitute a personal recommendation or advice. Past performance is no indication of future performance and tax laws are subject to change. We do not represent that any content is accurate/current. Trading derivatives carries the risk of losing substantially more than your investment and may not be suitable for all investors. You should consider whether you’re part of our target market by reviewing our Target Market Determination (TMD). Please read our Product Disclosure Statement (PDS), Financial Services Guide (FSG) and other legal documents and seek independent advice to ensure you fully understand the risks before you make any trading decisions. This information is under the copyright to Vantage and may not be used without its prior consent.
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