Before you start CFD trading, you need to know what exactly CFD is. CFD stands for contract for difference.
CFDs are products that are derivative in nature, which means that their value is actually a derivative of the value of another asset. To keep the picture bit more clear, CFD will always follow the price movement that involves the underlying asset. If I go ahead and buy a Panasonic share CFD, then if Panasonic’s share price increases, so will my CFD value.
How did the term CFD pop out?
It started out as a leveraged futuristic cash flow, which was later given the term equity swap. It originated from London in the early 1990s, with hedge funds being the dominant user. CFD began to appear in the retail market, too in the later 1990s. As time went by, the CFD brokers increased exponentially in numbers. These were doubled between 2010 and 2016. The clients belonging to the UK alone held 3.5 billion euros in their accounts.
There is also a lot of s that are involved in CFD, and as a result, the regulating authorities are becoming strict with each passing day. The CFD exchange was closed in the Australian market in 2014 while in countries like the US and the UK, it is totally banned. After the summer of 2018, ESMA (European financial regulator) created rules that were tighter than ever for CFD brokers.
Are there any Advantages of CFD trading?
1. Lower trading fees. Trading fees may refer to the brokerage charges or any trading fees that might be involved, and in CFD trading, it is less when compared to any other type of trading. It can also vary from country to country. For example, traders from the UK are exempted from any stamp duty that exists.
2. Possibilities of “going short”: When it comes to CFD trading, it becomes comparatively easy to go short, meaning that a broker can bet on prices that are about to go down. This is something that is termed as “tricky” for retail investors.
3. The market is wide, so is the product: As mentioned above, the CFDs follow a derivative nature, and because of that, the brokers can offer products that are diverse in nature like basic stocks to more exotic ones like cryptocurrencies.
4 Room for smaller trades: One very good feature of a CFD is that the investor can choose the size of the trade, and it can be as low as a couple of dollars. This might not be the case with the underlying product whose derivative is that particular CFD. When it comes to trading the actual product, the minimum trade size can reach up to tens of thousands of dollars—”Oil”. Ring a bell?
Leveraging leverage itself: May it be CFD or any other form of trading, a low amount of investment can give a good return if the leverage is leveraged elegantly. For example, say an investor bought a share CFD for $100 on a 10% margin or ten times the leverage. This practically means that the investor has to pay $10 only; the rest of the price is leverage. If the price of the share goes up by $ 109, the return received by the trader will be equal to 90%. On the contrary, if the actual shares were bought, the return would have been only 9%. Yes, the last part does sound too good to be true, but it is.
Leverage can also put an investor at a huge loss if the prices do not go as planned.
Most Common CFD Trading Tips:
1. Use stop-loss orders: Stop loss order means that an investor tells his broker to sell an asset when it reaches a particular price point. The only rule that is and that will forever be deployed for stop-loss orders is to USE THEM. Always use them. A trader has to make sure that the downside is limited by using the stop-loss orders.
2. Use a demo account before an actual one: Before hurriedly using the CFD trading account, the trader should always begin with a demo account(Open Demo Account Now), which is provided by almost all the brokers in the beginning. This can be a method to test the CFD by not investing real money and can be a really good Boot-camp kind of a deal for novice traders. The risk of involving real money here is zero, so all the mistakes can be deliberately made in order to not make them when there is real money involved.
3. Do the homework: Understand what has to be done in terms of CFD trading as well as a particular investment that is about to be made. Trading shouldn’t begin on the spot before knowing what the current market is or forex CFDs shouldn’t be traded instantaneously before understanding the currency pairs and their differences. A trader should focus on practicing one technique 100 times more than practicing 100 techniques one time each.
4. Limit the use of leverage: Leverage can be used on any level that exists, but if there is an option, a trader should scale down the use of leverage. This majorly depends upon the risk management profile of the trader.
5. Use of the correct trade position: There are brokers who will not let a trader lower the leverage. In that case, the trader can go ahead and lower the trade position. Also, the trader should always be aware of the risk level that exists, if any.
6. Do your own analyses: For every useful information on the web, there are at least 200 pages worth of gibberish that a trader can come across. One should be able to differentiate between what information has to be consumed and what has to be left for good. That is what analysis is. Traders coming from technical backgrounds can use their knowledge to gain the upper hand in this particular area because sometimes analysis involves machine learning and AI.
7. The trader must be well aware of the situations that can arise when a particular trade is made. He should be able to coin various strategies according to various possibilities that can occur. Here, the best case scenarios should be often ignored, and the worst-case scenarios should be paid undivided attention.
8. Let the money flow, don’t run after it: A trader should make sure that he does not start running after the loss that just occurred and should stick to the basic strategy that he made. When loss of money is involved, the emotional self starts taking decisions in place of the logical self and that’s when mistakes happen. Such a situation should be avoided at any cost. If not, then the losses will be greater, situations will get grimmer.
9. Make sure that the leverage works for you: One simple advantage of having higher leverage is that an investor can invest more money than he actually has as capital. This is a very good feature, but also, it needs a very reasonable approach. This can be easily understood by the concept of mortgages. Someone can own a house or a car without having the actual capital to pay back. But can they payback? This is the question that should click before investing via leverage.
This cannot be focused enough that leverage is a good sidekick, but when the trends are not according to the plans, it will kick you where it hurts the most.
10. Keep expecting some rainy days: There are going to be days when the investments that were made will go right against you. There has to be enough capital with a trader with the help of which, correct calls regarding a loss can be made instantly.
11. Don’t put all your eggs in one basket: Warren buffet has been saying this since he got a chance to speak for the people. There are a lot of places where one can invest in. If an investor has the capital to invest in oil, then he, for sure, has the capital to invest in cryptocurrency. Rather than investing the total amount in one place, break it down into small sizes or pockets and then invest each pocket in a different field. This increases the chances of counter-balance.
If one pocket fades out, the other pocket can fade away any loss that has just occurred volatile returns are often the consequence of CFD trading. A trader should make sure that it is not their only source of income.
12. make sure that your CFD broker is reliable: While driving a car, a Ferrari and a Volvo make all the difference there is, in the world. The same goes for CFD trading. Brokers are smart. When a trader trades more than frequently, a big chunk is always lost under the name of trading fees. A trader should make sure that not a very big pile of his earnings is swallowed in the same form. One more thing that has to be kept in mind is safety. Scams should be avoided at all costs. We also recommend you some brokers like Primefin, InvestBy, Etoro read broker review our site and enjoy CFD trading.