
An Introduction To CFD Trading (Part 1)
By Kurt Magnussen
Here's a really simple yet useful tutorial on CFD trading that
will get you up and running very quickly if you're new to CFD
trading.
By the time you finish this article, you'll know how CFDs
work, what makes them highly profitable, and understand
the costs involved in CFD trading.
CFD stands for Contracts For Difference, which is a derivative
product, where you profit from changes in the prices of
stocks and shares.
For example, if you buy a CFD on a stock that's $5.00 and
the price rises to $5.50, then you profit from that change in
price. So if you bought 1000 CFDs, then your profit is $500.
That is, the value of the CFDs mirror the underlying stock
prices, and you can profit on this movement.
The reasons why CFDs are a very popular trading product,
and understandably so, are:
1. CFDs are traded on leverage, and this leverage is typically
10 to 1, with some CFD brokers providing 20 to 1 leverage.
This means that a trader with a small float can make decent
profits from trading the stock market by using CFDs. For
example, you may have a stock trading system that makes a
30% return per annum. On a $5000 float, this is $1500
profit in one year. With CFDs, because of the leverage, the
same system can now produce a 300% return, which is $15
000 profit in one year.
2. You can just as easily short sell CFDs as well, and
therefore profit from falling markets. This greatly increases
the profitability of a trading system because trading
opportunities increase dramatically, and the fact that you
can profit from both bull and bear markets.
3. The costs in CFD trading are relatively low when
compared to stocks. This is especially so, since for a similar
and often smaller cost per trade, you can gain 10 or greater
times the results from a trade due to the leverage available.
The 2 main costs in CFD trading are interest and leverage.
We'll come to these in a moment.
4. You can set automatic stop losses. This means that it will
take you less time to trade, remove the emotion from
exiting a trade when you should, and allow you to exit as
the stop is hit, not a day later. You therefore avoid the
slippage due to getting out of a trade later than when you
intended.
5. You can place all your orders in the evenings. With many
CFD providers, you can place orders to enter a position the
night before. For people who are working, this is a great
advantage as they can do all their trading (place their orders
to enter and their stop losses) in the evenings, and not
need to be at the computer screen or call their broker
during the day. Also, if they have any stop losses that need
adjusting, they can do so in the evenings as well. Their
trading routine with a mechanical system can be about 10
15 minutes per day.
So these are the advantages of CFDs that have made
trading accessible to so many people because they provide
large returns for a modest float, and can also be traded once
a day as well.
Now, we mentioned that there are 2 main costs in CFD
trading. Let's have a closer look now at each of them:
1. Commission. With some CFD providers, there is in fact no
commission. This also greatly increases the profitability of
your CFD trading systems, as well as the fact that you can
benefit hugely from the leverage. With other CFD providers,
there may be a commission of say 0.15% of the trade size or
$15, whichever is greater, each way. These costs are similar
or less than the commission associated with stock trading,
especially when you consider that the multiplied profits that
the leverage gives you.
2. With CFDs, there's interest charged for long positions that
are held overnight. For short positions, the interest is paid to
you. The amount of interest charged is usually a reference
rate plus approximately 2%, and the interest paid is usually
the same reference rate minus approximately 2%. And the
reference rate is usually a major bank's overnight interest
rate.
For example, the interest rate charged for overnight held
long positions may be 7.5% or 0.075 per annum. To
calculate how much this is for a trade, we need to make it
"pro rata". That is, we'd need to divide the 0.075 by 365,
multiply it buy the number of days in trade, then multiply it
by the trade size. For example, for a trade size of $10 000,
held for 14 days, the interest cost is about $28. Not a huge
cost. For a short trade, the interest is paid to you, so will
offset the cost rather than contribute to it.
So there you have it.
You now understand the benefits of trading CFDs and why
they're a trading instrument that allows people with a
modest float to make very decent returns, as well as
understand the costs involved with trading CFDs.
To learn more about CFD trading, watch out for part 2 of
this article.
If you'd like to learn more now about CFD trading, go to this
page with a comprehensive tutorial on CFD trading:
http://www.thecfdtrader.com/cfdtradingtutorial.php
About the Author Kurt Magnussen makes it easy to learn the keys to successful
CFD trading, quickly & easily. To learn more valuable tips and
hints on CFD trading, including how to choose CFD systems,
go to http://www.thecfdtrader.com
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Some other articles by Kurt Magnussen  CFD Trading Tutorial: Part 2 We're going to put it all together by showing you an example CFD trade, so you can easily see how CFD trading works.
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