Easily explained, a CFD trading (Contract for Difference) is simply an agreement made between 2 parties that have agreed to exchange the difference they get between opening and closing price of a specified contract. There are 4000 global markets where CFDs can be traded, including in Australia.
CFD trading makes it possible for traders to speculate on price movement in different markets, including forex. Since the trader is speculating on the price movement, as opposed to owning the underlying instrument of trade, you will not have to pay stamp duty on your profits.
Why investors are fond of CFD trading
The reasons investors prefer CFD trading in financial markets include:
Tax efficiency – they are not required to pay stamp duty.
Flexibility – you are allowed to trade on rising (going long) and also falling (going short) forex markets.
Products are leverage – you only use a small amount of money to gain control of a larger financial portion.
The hedging tools – investors can make use of CFD trading to offset potential losses against the value of their physical investments by going short.
How CFD trading works
Once you open a CFD position, you get to choose the number of CFDs you feel comfortable trading. Your profit will increase with every market point move. If you have a feeling that the price of the forex market you chose will go up, you simply click on buy. This increases your profits in case there is an increase in the price.
Even so, in case the price falls, you suffer a loss in your investment against every point the forex market moves.
For instance, if you anticipate that the price of forex will go up, you can place a trade of 5 CFDs for the specified price. If the market rises 30 points and you close your position, you will have made a 150 profit for the 5 contracts you bought. If the market points move against your market, you can lose up to 150.
Steps to trading CFD
- Choose the forex market you want to trade in. there is numerous analysis available online on the different markets available.
- Decide whether to buy or to sell. If you want to buy, simply click on the ‘buy’ option. It is advisable to buy only when you think the value will increase. If you think the market will fall, you can opt to sell your contracts.
- Decide on the number of CFDs you would want to trade.
- Remember to add a stop loss. This is an order that is used to close your position in a CFD forex trade at a specified price in case the market points move too far against the trader.
- Keep track and close your trade. Once your CFD trade is placed, you will get a profit and loss update as it happens. You can decide to exit the trade by simply clicking on the close trade option.
Risks associated with CFD trading
Markets move very quickly and sometimes unexpectedly. Political instability, natural disasters, and major earnings announcements are some of the factors that can affect forex trading. As much as volatility sometimes presents opportunities to trade, it also poses significant risks.
CFDs are leveraged products. This means that to open a position, the investor is only required to deposit a small amount, a percentage of the trade value termed as a margin. This means that investors have access to larger position for just a small starting capital. If the market points move in the investor’s favor, the gains are multiplied in the investor’s favor. Even so, your losses are also magnified in the same way should the market points move against the investor.
As an experienced Australian trader, you need to understand the risks involved and find ideal ways to manage the risks for you to enjoy successful trading. Traders can make use of risk management tools to limit potential losses without having to cap their profit potential.