If you're new to CFD trading, this really simple but helpful guide will get you up and running very quickly.
By the time you're done reading this article, you'll know how CFDs work, why they can be very profitable, and how much it costs to trade CFDs.
Contracts for Difference, which is what CFD stands for, is a derivative product that lets you make money from changes in the prices of stocks and shares.
For instance, if you buy a CFD on a stock that costs $5.00 and the price goes up to $5.50, you make money from the price change. If you bought 1,000 CFDs, you would make $500. That is, the value of the CFDs is the same as the price of the stock they are based on, and you can make money from this.
CFDs are a very popular way to trade, which makes sense, for the following reasons:
- You can just as easily sell CFDs short and make money when the market goes down. This makes a trading system much more profitable because there are a lot more opportunities to trade and you can make money in both bull and bear markets.
- CFDs are traded using leverage, which is usually 10 to 1 but can be 20 to 1 with some CFD brokers. This means that a trader with a small amount of capital can still use CFDs to make money on the stock market. For example, you might have a system for trading stocks that gives you a 30% return every year. This is a $1500 profit on a $5000 float in one year. With CFDs, because of leverage, the same system can now make a 300 percent return, which is a $15 000 profit in one year.
When compared to stocks, the costs of trading CFDs are pretty low. This is especially true because you can get 10 or more times as much out of a trade for the same or a lower cost per trade. This is called leverage. Interest and leverage are the two main costs of trading CFDs. We'll talk about these next.
- You can set automatic stop losses. This means it will take you less time to trade, you won't be influenced by your feelings when you should get out of a trade, and you can get out as soon as the stop is hit, not a day later. So, you don't lose money because you got out of a trade later than you planned.
- You can put in all of your orders at night. With many CFD providers, you can put in an order the night before to open a position. This is a great benefit for people who work during the day because they can do all of their trading (place orders to enter and stop losses) in the evenings instead of having to be at their computer screen or calling their broker during the day. Also, if they need to change their stop losses, they can do that in the evenings. With a mechanical system, they may only trade for 10 to 15 minutes a day.
So, these are the benefits of CFDs, which have made trading possible for a lot of people because they offer big returns for a small investment and can be traded once a day.
Now, we've said that CFD trading has two main costs. Let's look more closely at each of them now:
- With CFDs, long positions that are held overnight are charged interest. For short positions, you get the interest. Most of the time, the amount of interest charged is a reference rate plus about 2 percent, and the amount of interest paid is the same reference rate minus about 2 percent. The overnight interest rate of a major bank is often used as the reference rate.
- Government. There is no commission with some CFD providers. This also makes your CFD trading systems much more profitable, and the leverage makes it possible for you to make a lot of money. With some other CFD providers, the commission could be, say, 0.15 percent of the size of the trade or $15, whichever is higher. When you think about the multiplied profits that leverage gives you, these costs are the same as or less than the commissions that come with trading stocks.
For example, the interest rate for long positions held overnight may be 7.5%, or 0.075 per annum. We need to make it "pro rata" to figure out how much this is for a trade. That is, we'd have to divide 0.075 by 365, multiply that number by the number of days in trade, and then multiply that number by the size of the trade. For example, the cost of interest for a trade worth $10,000 held for 14 days is about $28. Not a big price. For a short trade, you get the interest, so it will cancel out the cost instead of adding to it.
So, now you know.
You now know the benefits of trading CFDs and why they are a good way for people with a small amount of capital to make very good returns. You also know what it costs to trade CFDs.
Watch for part 2 of this article to learn more about CFD trading.
Go to this page for a full explanation of CFD trading if you want to find out more right now "http://www.thecfdtrader.com/cfd-trading-tutorial.php
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tutorial on how to trade CFDs
