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Trading lessons, what is CFD trading?
‘Contract for Difference’ explained. More importantly, how to make money from the news!
If you are new to the markets but interested in trading there are numerous ways to invest and enter the financial world.
The main reason for this blog is to find opportunities associated with market fundamentals, news! If you can understand and get to grips with a system of trading, sometimes, news events can give you massive opportunities.
Don’t get too bored reading this, its not an exam and we always recommend a new trader to activate a practice account to get to grips with the platform of your choice, how to activate a trade, how to close at profit etc. without using your real money at the start.
CFD trading can give you quick access to the markets with little initial capital.
One of the most popular instruments in recent years is CFD trading. Mainly due to the advancement of the internet and fintech developing easy to use platforms. I will try to explain what this is all about in simple terms but be assured there is a lot of material, including videos that will help you to get to grips with some of the jargon associated with the markets & CFD trading.
To get to understand and eventually begin to trade is not as daunting as it may seem for a new trader. The hardest thing to learn, is which direction the market or asset you are trading is going and when to close for profit or even when to close at a loss.
CFD trading is defined as ‘the buying and selling of CFDs’, with ‘CFD’ meaning ‘contract for difference’. CFDs are a derivative product because they enable you to speculate on financial markets such as shares, forex, indices, and commodities without having to take ownership of the underlying assets.
Ok, in simple words, if I want to trade a stock, such as Apple, via CFD, I am not actually going to buy the stock or own the stock, I will be trading the price of the Apple stock at the time I decide and either make profit or losses depending on the direction I decide. So, if Apple stock is $130 per share, I believe it will rise today, I will enter buy and if the price goes up, I make money, this is just a simple example. Conversely, If I trade to buy and the Apple price drops, during the trade I will lose. There are a lot of factors to consider, such as holding the trade until it goes in my favour or closing the trade early even if I made only small profits. Experience will assist the new trader as to what actions to take during a trade.
One of the main benefits of CFD trading is that you can speculate on price movements in either direction, with the profit or loss you make dependent on the extent to which your prediction is correct with little initial capital.
Some of the main features and uses of contracts for difference:
Short and long CFD trading explained.
Simply put, short means you sell, long means you buy, or high & low.
CFD trading enables you to speculate on price movements in either direction. So, you can simulate a traditional trade that profits as a market rises in price, you can also open a CFD position that will profit as the underlying market decreases in price. This is referred to as selling or ‘going short’, as opposed to buying or ‘going long’.
If you think Apple shares are going to fall in price, for example, you could sell a share CFD on the company. You’ll still exchange the difference in price between when your position is opened and when it is closed but will earn a profit if the shares drop in price and a loss if they increase in price.
With both long and short trades, profits and losses will be achieved once the position is closed.
Leverage in CFD trading explained
The textbook definition of “leverage” is having the ability to control a large amount of money using none or very little of your own money and borrowing the rest.
This is probably the most important thing to get to grips with understanding CFD’s.
Leverage, which means you can gain exposure to a large position without having to commit the full cost of the asset.
Say you wanted to open a position equivalent to 10 Apple shares. With a standard trade, that would mean paying the full cost of the shares upfront, say 10 x $130, costing you &1300. With a contract for difference, on the other hand, you might only have to put up a fraction of the cost. Most regulated European brokers will offer a leverage to a new trader of 5:1. Therefore to open 10 Apples shares on a CFD you will only require $260, with reference to this example. The good news is that you will be trading the equivalent of 10 Apple stock shares, with less capital but your profits will be the same as if it was 10 shares. If you predict correctly and say, after a good earnings report, the stock jumps 10%, you will have made $1300 plus 10%, equating to $ 1,430, with your $260 investment.
Not bad, however, leverage goes both ways, if you get the trade wrong and the asset goes against your forecast, the losses will also be amplified with your leverage. That is why it is important to understand, stop loss and take profit.
The adage is this, “Leverage is a double-edged sword.” or “Leverage is a two-way street.”
Leveraged trading is sometimes referred to as ‘trading on margin’ because the funds required to open and maintain a position – the ‘margin’ – represent only a fraction of its total size.
Margin is the amount of money needed as a “good faith deposit” to open a position with your broker. It is used by your broker to maintain your position. Your broker basically takes your margin deposit and pools them with everyone else’s margin deposits and uses this one “super margin deposit” to be able to place trades within the interbank network.
Margin is usually expressed as a percentage of the full amount of the position. For example, most forex brokers say they require 2%, 1%, .5% or .25% margin.
Based on the margin required by your broker, you can calculate the maximum leverage you can wield with your trading account.
Hopefully, you got to a bit of a better understanding of this form of trading.
Other important things to know are the spread and commission you pay to trade.
CFD prices are quoted in two prices: the buy price and the sell price.
The sell price (or bid price) is the price at which you can open a short CFD.
The buy price (or offer price) is the price at which you can open a long CFD.
Sell prices will always be slightly lower than the current market price and buy prices will be slightly higher. The difference between the two prices is referred to as the spread. The amount of commission your broker charges for each trade.
The cost to open a CFD position is covered in the spread: meaning that buy and sell prices will be adjusted to reflect the cost of making the trade.
Some brokers, the ones we have partnered with on this platform no longer charge a spread on stocks.
Instead, the buy and sell prices match the price of the underlying market price and the charge for opening a share CFD position is commission-based. By using commission, the act of speculating on share prices with a CFD is closer to buying and selling shares in the market.
This is a great benefit for a trader who wants to jump in and out of the market for a short period, for example the upcoming earnings reports of the major listed companies, which are coming soon.
Earnings season is the period during which many publicly traded companies release their quarterly earnings reports. In general, each earnings season begins one or two weeks after the last month of each quarter (December, March, June, and September).
Now for the important things.
If I have not bored you to death yet, and you are still interested in speculating the markets via CFD’s, there are always big news events, data released, geopolitical occurrences that give a trader a chance to make some decent money.
1. Volkswagen emission scandal, what happened to the stock price?
2. Brexit referendum result, what happened to Sterling? One of my traders made $42,000 with a $3000 investment, yes!
3. War breaks out in the Middle East, what happens to the oil price? Gold prices, as safe havens.
4. Devastating weather destroys Brazils coffee crops. What happens to the price of coffee?
5. Joe Biden, launches the biggest stimulus package in US history, how do the markets react?
6. Chinese regulators announce an anti-monopoly investigation of e-commerce giant Alibaba Group. Stock drops?
7. Elon Musk considers buying Bitcoin? What happens to its price?
8. Boeing has terrible accidents involving its new plane and its grounded? What happens to the stock?
9. Covid19 decimates the tourism industry, what happened to easyJet’s stock price?
10. Netflix’s beats market expectation after its report, due to lockdown. How will the price move?
Example of an earning report .
Citigroup profit beats, but shares dip on higher costs, weak revenue.
The list is endless and if you can react quickly to some of these fundamental news reports, you can find some profitable trades.
I always mention this to traders, don’t go to a gunfight without bullets. What do I mean? To fund a CFD account you need around $500 to start, maybe less depending on the broker, $500 may sound like a lot of money, but not in the financial markets. If you are primed and you see some breaking news and pounce quickly, you can get some great results. Logically, there will always be a risk to leveraged trading, but experience helps as well as realistic expectations of returns.
Are you intrigued yet?
Most brokerage offer free demo/practice accounts, and they are very easy to set up, so if you want to profit from earning season, give it a go.
Interested in trading, let us know.