CFD Trading 2020 – Guides and Brokers

What are CFDs?

A CFD is a contract between two parties. They agree to pay the difference between the opening and closing prices of a particular market or asset. Hence, it is a way to speculate on price movements without owning the actual asset.

The performance of CFDs reflects the underlying asset. Profit and loss are established when the value of that underlying asset changes in relation to the position of the opening price.

When trading CFDs with a broker, you do not own the asset being traded. You are speculating on the price move, up or down.

CFD example

Let’s use an example. Let’s say you select a stock with an offer price of $25 and you open a CFD with the value of 100 shares.

If buying stock the traditional way, the cost would be $2,500. There may also be commissions or transaction costs.

However, a CFD broker will usually only ask for a 5% return. This will allow you to enter the same trade but for only $125. (Actual level of leverage or margin will vary). This makes it an attractive hunting ground for day traders. The risk and reward ratio is increased, making short-term trades more viable.

When you enter your CFD, the position will show a loss equal to the size of the spread. This means that if the spread from your broker is 5 cents, you will need the stock to appreciate at least 5 cents to break even.

CFDs vs stocks

Using the example above: let’s say the price of the underlying stock continues to rise and reaches a bid of $26.00

If you own the stock, your holdings are now worth $2600. A good profit – ignoring the commissions or trading costs that the trader gets $100.

However, with the underlying stock at $26.00, the CFD will show the same $100 profit – but requires less to open, just $125. So in terms of percentages, CFDs return much larger returns. If the market moves in the other direction, the loss associated with our investment will also be greater – both the risk and the reward increase.

Of course there are other benefits to owning an asset than speculating on the price. We also omit commissions and spreads for clarity. But the above does not illustrate the relative differences in the two investment methods.

Application

Since you are day trading, you probably won’t hold any CFD positions overnight. Instead, you may end up placing a large number of CFD trades in one day. To maximize your profits, you will want to focus on liquid volatile markets. Trading CFDs on oil, bitcoin and forex are all popular options, for example.

Benefits of CFDs

You may have gleaned some of the above advantages from CFDs, but let’s break them down and add a few more.

• Leverage – Leverage CFD is much higher than traditional trading. You can get a margin requirement of as little as 2%. The rate usually depends on the underlying asset. Volatile stocks or cryptocurrencies, for example, can reach 20%. While a low margin will allow you to take large positions with less capital, losses will also hit you harder.
• Accessibility – The best CFD brokers will allow you to trade in all major markets. With so many markets that means CFD trading hours are efficient 24 hours a day. You will just need to check your broker’s trading hours.
• Cost – The CFD trading system incurs minimal costs. You will find many brokers that charge little or no fees for entering and exiting trades. Instead, they make money when you have to pay the difference. The size of the spread will depend on the volatility of the underlying asset. Note it is usually a fixed spread.
• Less Shortening Rule – Some markets enforce rules that prevent you from shorting at certain times. They may require larger margin requirements for short instead of long. However, the CFD market usually doesn’t have such rules, since you don’t actually own the underlying asset. This means no borrowing or shortening costs.
• Less Day Trading Requirement – Some markets require significant capital to start trading. This limits you on how many trades you can make and how profitable in turn. However, an online CFD trader can set up an account for as little as $1,000 to $5,000.
• Diversity – Regardless of your interest level, you will probably find a CFD vehicle. You can start trading CFD FX, as well as using funds, commodities, cryptocurrencies and index CFDs.

 

 

CFD Risks

While there are many benefits, there are still a few downsides to CFDs that you should be aware of.

• Regulation – The CFD industry is not thoroughly regulated. This means it is increasingly important that you choose the right broker. You need to make sure they are trustworthy and in a strong financial position. For further instructions, see our brokers page .
• Margin Trading  – While margin increases profit potential, it also increases risk. It’s very easy to lose sight of the total exposure you have when using margins. $2000 worth of open positions using 5% profit margin means exposure to $40,000 worth of contracts. You are effectively borrowing $38k from your broker. If the market goes against you, the loss can exceed the deposit. An awareness of total exposure is important.

How to start trading CFDs

One of the selling points of trading with CFDs is a simple way to get started. You will need to follow just five simple steps.

1. Choose a market

There are thousands of individual markets to choose from, including currencies, commodities, plus interest rates and bonds. Try and opt for a market that you have a good understanding of. This will help you react to market developments. Most online platforms and apps have a search function that makes the process quick and hassle-free.

2. Buy or sell

If you buy you go long. If you sell you go short. Bring your trading ticket with you on your platform and you will be able to see the current price. The first price will be the bid (sale price). The second price will be the offer (purchase price).

The price of your CFD is based on the price of the underlying instrument. If you have reason to believe that the market will rise, you should buy. If you believe it will reject you should sell.

3. Trading size

Now you need to choose the size of the CFD you want to trade. With CFDs, you control the size of your investment. So even though the price of the underlying asset will vary, you decide how much to invest. However, brokers will have minimum margin requirements – or more simply, a minimum amount required for a trade to be opened. This will change property by property. However, it will always be made clear, as will the total value (or your exposure) of the transaction.

Volatile assets like cryptocurrencies typically have higher margin requirements. So, a position with $2000 worth of Bitcoin exposure, might need a $1000 margin, for example. A well-traded stock, however, may require only 5% margin. So a $2000 position on Facebook, can only claim $100 of account funds.

4. Add stops and limits

This will help you secure your profits and limit any losses. Most CFD strategies for beginners and experienced traders will use the use of stop loss and/or limit orders. They stick to your risk management strategy. Once you have determined your risk tolerance, you can set a stop loss to automatically close the trade once the market reaches a predefined level. This will help you minimize losses and keep your account in the black – leaving you fighting another day in your next trades.

The limit order instructs your platform to close the trade at a better price than the current market level. If you choose a trading bot, they will use pre-programmed instructions like these to enter and exit trades that fit your trading plan. This is perfect for closing trades near resistance, without having to constantly monitor all positions.

5. Follow and close

Once you have placed your trade and stop or limit your loss, your profit will change along with the market price. You can see real-time market prices and you can add or close new trades. This can be done on most online platforms or through apps.

If your stop loss or limit order has not been activated, you can close it yourself. Just select ‘close position’ from the location window. You will be able to see your profit or loss almost immediately in your account balance.

Strategy

Choosing the right market is a hurdle, but without an effective strategy, your profits will be meager. You need to find a strategy that compliments your trading style. That means it plays to your strengths, such as technical analysis. It also means it needs to match your risk tolerance and financial situation.

Here two popular and successful CFD trading strategies and tips have been outlined.

Breakthrough strategy

This simply requires you to define a critical price for a given security. When the price hits your key level, you buy or sell, depending on the trend. The main thing to remember with breakout trading is to avoid any trades when the market doesn’t provide a clear signal.

If you can’t tell which direction the general trend is headed, skip it. This is where detailed technical analysis can help. Using charts to identify patterns will give you the best chance to tell you where the trend is headed.

Opposition strategy

This is all about timing. Your plan is based on the knowledge that trends don’t last forever. If the price of a stock is on a downtrend then you identify a point that you believe is near the end of the trend. Then you enter a buy position in anticipation of the trend turning in the other direction.

You can follow the exact same procedure if the price is rising. You can short a rising stock when you think a drastic change is about to happen. Both Wave Theory and a range of analytical tools will help you determine when those changes will take place.

For more guidance, see our strategy page .

 

CFD Trading Tips

If you are looking to really increase your profits, consider these tips from top traders. Learn from their mistakes and hopefully, you won’t run into such costly pitfalls.

Control your leverage

Leverage is your greatest asset when you make the right trades. The temptation to increase your position size when you win is hard to resist. However, there is always a loss on the horizon.

You don’t want to be the trader who turns a small account into a big one, only to end up at a square. So you need to be smart. No one wants margin calls and the stress that comes with big losses. As Paul Tudor Jones famously said, ‘Don’t focus on making money, focus on protecting what you have.’

Having said that, start small to begin with. Keep your exposure relatively low relative to your capital. You should not use more than 3 times your account size, especially at the beginning.

As your capital grows and you create folds in your strategy, you can slowly increase your leverage.

Please keep the magazine

A bit like a diary, but exchange the description of your crush for entry and exit points, prices, location sizes and so on. This will be your bible when looking back and identifying mistakes. CFD trading journals are often overlooked, but their use can prove invaluable.

Hindsight is a powerful force, don’t waste it. You will be able to identify patterns, reflect on your trading emotions and rationalize strategies. A thorough trading journal should include the following:

• Musical instrument
• Time you enter and exit a trade
• Reasons for commercial, technical, news, etc.
• Whether it’s profit or loss
• Evaluation of your trading performance (including whether you followed your trading rules)
• What do you learn from trade?

It sounds time consuming but it will allow you to continuously review and improve. You’ll make smarter and faster decisions, while people who don’t need to scratch their heads wondering what they’ve done wrong in the past few weeks.

Stop using

Used correctly, you should be able to minimize your losses, keeping you in the game. Every trade you enter needs an explicit CFD stop. This is because emotions are bound to run high and the temptation to hold on a little longer can be hard to resist. As William O’Neil correctly pointed out, ‘to lose is the most serious mistake of most investors.’

So define a CFD stop outside of market hours and adhere to it religiously. This will also help you anticipate your maximum loss. You can then use the time you will be fighting an internal battle to research and prepare for the next trade.

Demo account

Once you’ve done your research and you finally have the capital to start trading, it’s hard to resist jumping in. However, day traders who convert will test their strategy with a demo account first.

A lot of brokers offer these practice accounts. They are funded with simulated money, making them the perfect place to make mistakes before your real money arrives. Not only can you test your strategy and familiarize yourself with the CFD trading market, but they are also an effective way to try out your broker’s trading platform. You can be sure that it has all the charting and analytical tools your trading plan requires.

Once you feel comfortable and see consistent results on your demo account, then upgrade to a live account.

Education

No one likes to hear it, but school doesn’t end. The best traders never stop learning. You need to keep up with market developments, while practicing and perfecting new CFD trading strategies. Learning from successful traders will also help. To do all of this, you’ll need to use a bunch of different resources. Just a few names:

• Blog
• Course
• Forum
• Video
• PDF files
• Books & Ebooks
• Podcasts
• Online guide

Regional difference

Tax

While you can trade CFDs around the world, where you are based and the markets you trade in can make a distributor expensive in the business. Trading CFDs in the US will be different than in the UK, Australia, India, South Africa and Singapore.

This is mainly because of taxes. Different countries view CFDs differently. Some consider them to be a form of gambling activity and therefore tax free. Some countries consider them taxable just like any other form of income.

Tax implications in the UK, for example, would see CFD trading fall under the capital gains tax requirements. Although you are exempt from tax of £10,100 annually, any profits in excess of that will be taxed. This means that you should keep a detailed record of your transactions so you can calculate them accurately at the end of the tax year.

So, before you start trading, find out if you will pay personal income tax, business tax, capital gains tax, or if you’re lucky, no taxes. Once you know what kind of tax liability you will face, you can incorporate that into your money management strategy.

For more detailed instructions, see our tax page .

Last word

Day trading CFDs can be relatively less risky than other instruments. Having said that, it will still be challenging to build and execute a consistently profitable strategy. If you want to become a successful CFD trader, you will need to use the educational resources above and follow the tips mentioned. As successful trader Alex Hahn pointed out, If you take control of your thoughts and emotions, nothing can stop you. ‘ So the ball is at half of your field now, go and turn it into gold.

Read more

• CFD Brokers
• Trading CFDs and trading stocks
• CFD trading and spread betting
• For specific countries
• Trading CFDs in Australia
• Trading CFDs in Canada
• Trading CFDs in India
• Trading CFDs in Singapore
• Trading CFDs in South Africa
• Trade CFDs in the US