Contract For Difference Trading Provides Flexibility – The Basics
In the CFD’s or ‘Contract for Difference’ trading you will not have to buy or sell the underlying assets, but you trade on their units. Here you can trade on price movements of worldwide financial products like shares, commodities, indices, treasuries, and currencies.
Advantages of CFD trading
- Trading on margin is possible
- There is no need to pay stamp duty
- You can sell (go short), if you feel the price will fall down
- CFDs can be used to hedge the physical portfolio
Margin & leverage
Margins are leverages allow you to trade with the amount much lesser than the anticipated gains. It means you just need to deposit a small percentage of total trade value and open a position. Trading on margin enables a trader to increase the returns.
However, the losses will also get magnified because they are based on full position value. It means you can lose more than capital deposited. Of course, there are risks, but with the proper technical analysis and discipline, you can make informed decisions, and make the winning trades consistently.
CFD trading costs
Spread – Just like stock markets, you need to pay spread in CFD trading. Spread is the difference between buy& sell price. For entering a buy trade you will use quoted ‘buy price’, and for exiting you will use the ‘sell price’.
Holding costs – Any positions open beyond the end of a trading day, will be subject to charges called as the ‘holding cost’. Holding costs can be negative or positive depending on position movement, and the applicable holding rate.
Commissions – Several trading platform charge commissions separately on CFD trading for shares, only. Commissions start from 0.10% on full position exposure, and minimum commission charges are $9. Commissions are charged, while opening and closing the CFD trade by a majority of brokerage firms
Market data fees – You will be charged a fee to activate relevant market data subscription for share CFDs.
CFD examples of trades are given below to understand easily.
- Buy company share in rising market
The CFD shares of an Oil Company XYZ quotes are 96/100 (96 is sell price & 100 cents is buy price). Spread is 2.
You feel that the price will rise, so you buy 10,000 units for 100 cents. The commission charge to open a position is 0.10% of 10,000 units, which is equal to $10.
Margin rate of Oil Company XYZ is 3%. It means you will need to deposit 3% of total trade value (10,000 units X 3%) that is $300.
- Result A – For correct prediction profitable trade
If price rises in the next week to 108/112 and you desire to sell at 108 cents. Now, commission is charged on exit trade at 0.10% on trade size 10,000 units X 108 cents = $10800 x 0.10% = $10.8
The price has risen to 8 cents from buy price 100 cents to 108 cents.
Calculate profit: 10,000 x 8 cents = $800 – $10 (entry) – $10.8 (exit) = $779.2 (total profit)
- Result B – For wrong prediction losing trade
If the CFD share prices of Oil Company XYZ collapse in a few days to 92/96. You decide to close trade at 92 cents. Commission charged on a trade exit – 10,000 units x 92cents = $9200 x 0.10% = $9.20
The price has decreased 8 cents, which is from 100 cents buy price to 92 cents.
Calculate loss: 10,000 x 8 cents = $800 – $10 (entry) – $9.20 (exit) = $780.8 (total loss)
Whenever the movement of price is in your favor then there is a gain, and if price movement is against you, there will be loss. Remember, the loss can be more than your deposits, but your winning trades will give you propionate higher profits. So trade smartly, and follow your strategies closely.