Introduction to CFDs
The CFD is one of the newer derivatives to hit the mainstream market even though it was first developed back in the early 1990s. It has grown to be one of the more successful methods of trading, especially in the UK and Australia and CFDs also tradable in a host of other countries. They are not tradable in the USA due to imposed restrictions on OTC instruments
When you open a Contract For Difference, you are agreeing to settle with the broker, the difference between the opening and closing prices of the underlying asset. The best way to explain this is by using a simple example:
CFD Example – trading 100 Rio Tinto (LON:RIO) shares
John thinks the price of Rio Tinto shares is going to increase and he therefore wants to go long with a Contract For Difference worth 100 shares. His CFD broker is quoting a bid price of 3512.50 with a margin requirement of 5%.
Using this example, the following calculation would apply:
100 x 3512.50 x 0.05 = £17562.5
Essentially this means that John would need to deposit around £17562.5 to open this position. If he wanted to speculate on Rio Tinto by purchasing shares outright, he would need to put up approximately £350,000.
This is one of the beautiful things about CFDs; brokers only require traders to meet their margin requirements to buy a contract. This allows for far more spectacular profits (and losses) than what share dealing can allow.
10 tips for Success
So what does it take to be a profitable CFD trader? Here are ten tips to help you on your way:
- Be prepared for setbacks
Anyone that has ever attempted to trade the financial markets has encountered setbacks and closed out loss making positions. Expect this and don’t see them as an indication that you aren’t/will not be successful at trading CFDs.
- Invest in good education
Knowledge is power and by constantly educating yourself on the various aspects of trading will undoubtedly make you more successful. Many of the more comprehensive courses can be quite expensive although some brokers provide access to some excellent education. ETX capital, for example provides access to training provided by a third party company that is well worth following.
- Network with experienced traders
There are some great communities out there where you can meet experienced and very successful traders. Spend a part of your day communicating on online forums that you can use to expand your CFD trading knowledge and hopefully pick up a quality tip or two!
- Keep trading records
It is advisable to take account of each and every trade you make and the profit and loss involved with each. By doing so, your head will feel much clearer and it will allow you to develop a better sense of what is and isn’t working, and under which conditions.
- Know when to get out
Profits are only profits when a position is closed and it is imperative you have pre-determined what you intend to make from a particular trade. Too many times, traders dwindle gains by being greedy and ignoring what they intended prior to opening a position. If you aim to make a 5% gain on a trade over a set time frame, set an order to sell once this has been achieved or a trailing stop to ensure your goal will be reached.
- Trade without emotion
One of the main flaws of unsuccessful traders is that they let their emotions get in the way. Trading can be extremely stressful and it can be easy to see that red mist washing over. Ignore any negative feelings and stick to your strategy to be successful.
Although diversity is a good thing for the more seasoned trader, many newbies find themselves in consistent negative territory as they try to trade on too many markets. You will become much more efficient if you specialise in one sector or a small number of sectors that follow each other closely.
- Trade with a plan
Rather than jumping into trading the financial markets, make sure you create a plan to guide you through each and every position. Things to consider are:
- * What markets you are going to get involved in?
- * How much money you are going to begin with?
- * Trade sizes.
- * The gains you wish to achieve from trades.
Make sure you stick to this plan!
- Use risk management tools wisely
One of the most important aspect of trading, not just CFDs, but any financial derivative is to use the risk management tools on offer wisely. Brokers will normally allow stop losses, guaranteed stop losses, trailing stops and limit orders. Make sure you protect your losses and gains by using these tools effectively.
- Learn/combine both fundamental and technical analysis
By utilising fundamental and technical analysis techniques, you stand yourself in much greater stead for making money while trading. Some people specialise in one or the other but by becoming proficient in each school of analysis, you will find yourself with an edge that only a small percentage of traders possess.