Making Money With CFDs

Archive for the ‘Learn CFD Trading’ Category

How do CFDs Work?

Contracts for Difference (CFDs) can sound rather complicated but are really very simple. With a CFD you pay the same price as you would for the underlying share. That means CFDs work in almost the same way as ordinary share dealing but have a range of additional features.

One benefit of trading CFDs is that you get the opportunity to take a larger position than you normally would if trading ordinary shares for the same outlay. When trading shares your broker will usually ask you to pay for the full amount of the transaction. With a CFD deal your broker will just ask you to make a deposit on the deal, which initially is often as low as 10% of the transaction value.

CFDs allow you to benefit from any market conditions providing you deal the right way. Not only can you profit from a rising share price by ‘going long’ you can also benefit from a falling share price by ‘going short’ (i.e. sell a CFD on a share you do not own). In these volatile markets going short can enable you to make profits where trading ordinary shares may not.

The best part of all about trading CFDs is you don’t pay any stamp duty – which effectively removes one of the greatest costs you face when trading normal shares.

Because of their geared structure, CFDs are high risk investments. Please read our full guide to CFDs and the CFD Important Investment Notes for full information on how CFDs work and the risk factors you should consider.

CONTRACTS FOR DIFFERENCE – TRADING STRATEGIES

HINT: TRADE THE FACTS

The same rules apply to CFDs as they do to share trading – In essence, they’re both about getting the direction of the instrument correct. Trading on rumours is a classic investor trait, which can often lead to losses as the event never materialises and the share price falls back.

HINT: DIVERSIFICATION

Overexposure in one particular asset class can quickly lead to losses (and gains). Diversifying your risk is well regarded amongst the most successful investors as the best way to reduce risk. Reducing risk can come in a variety of guises from investing in different sectors, taking short as well as long positions – creating a market neutral portfolio and trading across different markets. The most popular way of diversifying is by taking a position in an index, as opposed to the individual constituents. This way the impact of a large movement in a particular share, or even sector, will have less of an impact. Although you should always place a stop on your positions, it is particularly prudent with more exposed portfolios.

HINT: DO YOUR RESEARCH

Most CFD trading firms provide a range of research resources including charting, news and company information to keep you informed and help you make informed investment decisions. Keep yourself informed and up to date by making the most of the research centre.

TIP: DON’T OVERTRADE

Every investor has their own style of trading and you must decide what works for you. Just because you have the ability to trade frequently, doesn’t mean you have to! With competitive commissions and a high liquidity, the FX market is a classic example of where there can be literally dozens of trading opportunities throughout the day. You don’t have to trade every one of them to have a successful day.

TIP: CUTTING LOSSES

You will have losing trades. Decide on the amount you are willing to lose before you place the trade and stick to it. If you haven’t got the self-discipline to trade out of a losing position, place a stop on the trading platform and let the system do the hard work for you. The most successful traders are those who are very regimental in their use of stops. Quite simply, they rarely lose more money than they were initially prepared to lose. There are plenty of more opportunities, as long as you have retained the capital to take advantage of them!

TIP: UNDERSTANDING YOUR MARKET

Most CFD firms provide access to a range of global financial markets for you to trade. This wide selection is not an invitation to trade every market possible – it’s to provide a choice. As well as fully understanding the market and the news and data which impact its movements, make sure you fully understand how Barclays Stockbrokers offers the instruments and under what terms. Trade what you know.

TIP: CREATE TRADING TARGETS

Every trade should be entered into with one clear exit target if the trade is profitable and another for a losing trade. Limit and Stop orders are crucial to helping you achieve this. Don’t let a short-term trade become a long-term investment by not placing a stop. Moving your stop loss closer to the market price as your position becomes profitable allows greater flexibility in setting targets. You don’t have to call the very top or bottom of the market to regularly make money.

TIP: DON’T BE EMOTIONAL

CFDs are a very exciting way of trading, but don’t let emotion take over. The market is never wrong – and don’t try to prove otherwise. Sometimes the greatest discipline is to avoid the trade altogether. Like any good dealmaker – if the price isn’t right, walk away. Plan your trade and trade your plan.

TIP: MANAGING YOUR MONEY

Thrilling, exhilarating, gripping…. but these emotions will become few and far between without a sound, business-like approach to your CFD trading. Before you even start – only risk what you can afford to lose. Once you have established what proportion of your investment funds should be apportioned to CFDs you need to further break down your collateral into how much you are willing to lose on each individual trade. Then stick to this!

Quick profits and superior returns. Most new traders are only ever focused on those 2 points when looking for the fastest way to profit when trading Contracts for Difference or CFDs. If only it were that easy. With any leveraged product it is more than possible to make unusually large returns but it is also possible to make unusually large losses too and your priority should always be around protecting your principle. So is there a fastest way to profit when trading CFDs? Let’s take a closer look.

Building a solid CFD Trading Plan

In order to profit from CFDs you are going to need to establish a solid and well thought out CFD trading plan that is based on a good foundation. This generally requires years of studying the markets and finding opportunities that may have been overlooked by others. The foundation that you build your CFD trading plan on needs to stand up to the test of rigorous back testing and this is where most people fall short. Back testing your CFD trading plan over many years of data is essential and will give you key insights into the strengths and weaknesses of your system without you having to invest a cent.

Trusting your CFD Trading Plan

With a fully back tested Trading Plan you can now move into the markets with confidence. Fast profits usually come from high levels of leverage and you don’t want to put yourself in that position because high leverage means highs returns and high losses. We want to avoid the high losses at all costs. The only true way to make the nice profits in the market is to align your CFD trading plan with a powerful position sizing rule that allows you to maximize your wins and minimize your losses.

Really hitting the home runs

The beauty of back testing your CFD Trading Plan first is to get a feel for the average win and average loss the system has experienced historically. With this critical information you can begin to understand how big your wins are and plan an aggressive pyramiding strategy with your funds. You may find that several times over a year of trading you have outstanding wins. It is at those times that you want to have the most amount of money on those stocks or CFDs. That is the key to trading and winning – Having the most amount of money on the trades when you are winning and having the least amount on the trades when you are losing.

One of the most common questions I get asked is What is CFD Financing and how does it work? Today we’ll step into the CFD brokers world and have a look at what they offer and why they make so much money off of our money when we deposit it with them.

Make every dollar work for you

One of everyone’s goals when they enter the world of investing is to have every dollar work as hard as possible enabling you to earn strong returns. Trading is no different and we have many options available to use and one of the easiest to understand is trading Contracts for Difference. CFDs allow you to leverage your funds as you only need a small amount of margin to put up front.

For example you might want to trade a $10,000 position in Rio Tinto but you would only need around 10% or $1,000 of your own money in order to control the full $10,000 position. This is one of the best ways to get your money working harder for you.

Why do the CFD Brokers lend me money?

The Contracts for Difference brokers essentially lend you the full amount of your position even though you put up 10% margin. This is one of the greatest cash earners for the CFD broker. They then charge you interest on that money for every day you hold the position overnight. This is one of the greatest income streams for the broker.

The Cost of accessing more opportunity

Consider your borrowing fee’s the cost of accessing more opportunity as the CFD finance they charge is a relatively small amount. The beauty of this is that it allows you to find more opportunity with the limited funds you might have.

What are the CFD financing costs?

Typically your broker will charge you 2-3% on top of your countries cash rate. So in Australia the RBA might have the interest rate set at say 3.5% and so you might have to pay 3.5 + 2 = 5% per year calculated back as a daily rate. One of the interesting things about the CFD finance is that you only pay finance if you hold the position overnight (overnight is usually the New York close), which means you can day trade as much as you like with as big a position as you like and you won’t pay any CFD finance.

Now that you are involved in CFD trading, you have learned the ropes a bit and want to begin on your path to success. Hopefully you have studied trends and charting, if so then it is time to plan your strategy and creating your own Contracts for Difference trading plan.

The first step in developing your plan of action or trading plan is to decide what time frame you plan to monitor your trades as well as plan out how long you wish to stay in each trade. Generally most investors are not able to monitor their trades round the clock; the most common part of the day is at the close. CFD traders normally use a time frame of from a few days to a few months to stay within the trade. This of course will depend on what you are invested in. Once you are sure you have this set, you should move onto the next section.

Selecting your CFDs will be the next step. If you are still new to this, it is best to be very selective in what you are delving into. It is best in the beginning to trade CFDs which are currently in the uptrend. In general these should continue to perform well. If you have not, take the time to study a few step-ups, what this means is that by studying patterns from past top performing stocks, you can chart when the step-up was. Doing this often helps you gain confidence in your decision making.

Determining when you should enter and exit your CFDs position is the next technique you will want to work out. Entering the trade you would want to have set conditions, and to follow upwards trends once again. Remember also that when you first enter into the contracts for difference trade it will show a loss ((according to the CFDs broker fees). This loss will be equal to the spread. Take that into account when you set your initial stop. This will protect your capital. When your stop is approaching and you feel you want to stay within the position, you should be able to change the stop. Remember, at times a stop may take a bit of time to actually go into effect.

In conclusion, you should be sure to write out your strategy on paper. Write down each step and fill it in with your plans. Try very hard to follow it as this may prevent failure. You can always adjust it, or refine it as you trade your way in the Contracts for Difference sector.

Introducing CFDs 101. Today we’ll go through a basics guide to Contracts for Difference so you can confidently speak the lingo and get your head around the key concepts of this exciting product.

What exactly is a Contract for Difference?

A CFD is a derivative product that derives its price from the underlying market (stock, futures, index or Foreign Exchange) and allows you to trade on margin. In a nutshell, a CFD is exactly like trading the regular stock market, except you only need a small amount of money up front (margin) in order to control the full position.

Are CFDs risky and can I lose all my money?

Many people will tell you that trading a derivative like a CFD is risky and for the most part they are right. What they are missing is the point about who controls the risk. You see with Contracts for Difference you only need say 10% margin up front in order to control your total position. So if you wanted to buy $10,000 worth of BHP share CFDs then you would only need $1,000 of your own money.

This introduces a concept called leverage. In many cases you will be able to trade up to 10 times your account size which means your $10,000 account could hold positions totaling $100,000. Now that is extremely risky and you never wanted to be trading at such high levels of leverage. If you trade in this fashion you could in fact lose more money than what you start with which would be disastrous.

So in order to keep your risk to a minimum you need to trade a zero leverage and treat your account like a share trading account. So with $10,000 cash in your account, do not trade with positions exceeding $10,000. This means you are taking on no more risk than a standard share trading account.

What about CFD Financing?

One of the key differences between standard share trading and trading CFDs is the fact that with CFDs you are in effect borrowing 100% of the total position even though you put up a 10-80% deposit. That is one of the main ways CFD brokers make their money. Your broker will charge you a Contract for Difference financing rate which is usually the current cash rate plus 3% when holding a position long. Your broker will actually pay you the current cash rate minus 3% for short positions which is a nice bonus.

Can I short sell with CFDs?

Yes. One of the greatest advantages of trading this exciting product is the ability to profit when the market is falling. Short selling is alive and well and CFDs have greatly popularized this style of trading. Short selling is the exact opposite of trading long and for many newbies it can take a little time to get your head around the concept.