Once upon a time, the only sensible option for the average investor was to stick his or her hard-earned cash into a savings account with one of the big name banks. However, more recently, the return on savings held in a savings account has become almost non-existent. The general public began to look around for new forms of investment. And the financial world, realizing there was a niche that needed to be filled, decided to open up new forms of investment. It became possible for the ordinary person to invest in stocks and shares. And more recently, it has become an increasingly popular option for people to invest in foreign currencies. However, there is another way you can invest your money and many find it quite exciting. CFDs or Contracts for Difference is a new way of trading the derivative markets and the influx of top CFD trading brokers have made it a relatively easy option for you too.
What does CFD mean?
As weâ€™ve already mentioned, CFD stands for Contracts for Difference. But what does that actually mean? A CFD is an agreement between a buyer and seller, and it is a way of trading on financial markets without actually owning the underlying asset you are trading. CFDs are also leveraged derivative products, which means they can be traded on margin. In other words, you can control larger positions but only need to invest small amounts. This is also known as trading on margin, and you only need to put down a small percentage of the cost of the trade in order to open your position. Generally, this ranges between 0.1% and 1%. So, how does that benefit you as a CFD trader? It means you have much greater flexibility and have the option to spread your investments over a number of trades, and also in a range of markets. These could be:
- Foreign currencies
- Indices, for example, the FTSE 100
- Gold and silver or other commodities
- Company stocks and shares
However, at this point, we should also point out that trading on margin, or using leverage, also puts you at risk of significant losses. Because as you all know, any investment has the potential to go up and also down. Donâ€™t worry if there are some terms you donâ€™t quite understand because we will be providing a helpful glossary.
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What is CFD trading and how does it work?
First, we should point out you wonâ€™t be able to participate in this form of investment without help and assistance from the best CFD trading brokers. There are plenty to choose from and we will help you find one to suit you. There will be a CFD broker comparison, as well as a CFD broker list and weâ€™ll also be reviewing some of the big names in the industry. But enough of whatâ€™s coming up and time to get back to the questions. CFD trading is when you commit to buy or sell a financial instrument, at a specified time in the future. CFDs can be a long-term or short-term investment and can be in any of the markets weâ€™ve already mentioned. CFD trading doesnâ€™t require you to buy or sell the underlying asset, whether itâ€™s a physical share, commodity or currency pair. Instead, you buy or sell a certain number of units, depending on whether you think the price of the asset is going to go up or down. CFD dealing allows you to trade on future market prices, and it doesnâ€™t matter whether you think the market prices are going to go up or down. You get the choice of going short, in other words, selling, which will give you an opportunity to profit from falling prices. Or you can choose to go long (buy) if you consider market prices are more likely to rise.
You canâ€™t trade CFDs on your own – You need a CFD provider
Much like Forex trading, and trading in stocks and shares, to participate in the world of CFD market trading you will need to find top rated CFD brokers to work with. Opening an account with one of the best CFD brokers will allow you to participate in CFD trading without having to own the assets, or committing huge amounts of cash. There are a number of CFD providers to choose from, and they tend to fall into one of two categories. CFD brokers can be either market makers, DMA (Direct Market Access) providers, or a combination of both. Top CFD brokers who operate as market makers may also provide the service of traditional spread betting. This means you are trading against the CFD provider and the prices they display. The amount of commission you have to pay and the capital requirements are generally lower, but there is the issue of conflict of interest. CFD trading brokers who provide a direct market access service will send your orders direct to the order book. A DMA provider generally charges higher rates of commission and will require you invest larger amounts. Whichever type of CFD broker you choose you will have to take into account a number of different features and each broker will be different. There will be different commission rates, a variety of trading conditions, and a range of assets and markets you will be able to participate in. It will be up to you to decide which features are most important because it is very unlikely you will be able to find the best CFD trading brokers who can tick all your boxes. It may even be more beneficial and rewarding to open accounts with a number of the top CFD brokers so you can get a better mix of the features you desire. So, what kind of features should you be looking for?
What you should be looking for in a good CFD broker
There are a number of points you should be considering when comparing CFD brokers. These include:
- Is the broker licensed and regulated? Is the CFD broker licensed to operate and provide CFD trading services in the country where it is based? You should choose a licensed and regulated broker because this will mean your investment is better protected.
- What margin levels are required? All CFD trading accounts are really margin accounts so it will be sensible to check what the levels are and whether there are any rules to follow.
- What trading platform does the broker use? You will need to know whether the trading platform is reliable and if it offers a good selection of charts and tools to help with your trading decisions. It would also be useful to know whether the platform is mobile friendly.
- Are the commission charges reasonable? CFD trades incur commission charges and the top CFD trading brokers will make you pay a certain amount, but invariably it will be different, depending on which brokers you choose. There are also a number of CFD dealing brokers who will build charges into the spread. Itâ€™s important you appreciate what these are as they will have an impact on your profits.
- Is the broker a market maker or DMA? Youâ€™ll need to consider what youâ€™re looking for in a broker. Are you looking for lower capital requirements and lower interest charges?
- Are you prepared to accept the risk of a broker trading against you? If the answer to these questions is yes then you want to look for a market maker. If you would prefer the broker sends your orders to the order book but may also charge you higher rates of commissions and require larger amounts of capital, then you should consider DMA CFD brokers.
- What assets are available for trading? Do you want to only trade CFD forex? Would you like to be able to trade in a range of markets? Are there any restrictions in your country of residence that limit what you can trade? These are important questions you need to ask yourself when picking the best CFD brokers.
- Is there access to both domestic and international markets? There will be some brokers that only offer access to domestic markets and some that offer a mixture of the two. Which is the best? Both have merits. Youâ€™ll be in a better position if you are based in the same country as your broker to trade in domestic assets. Because, for example, a broker located in the UK is bound to be well-versed in the UK stock market and know more about UK stock trading. Traders who are working with a broker located in another country may be better served with a mix of both international and domestic markets.
- What trading resources are available? Successful CFD trading requires careful analysis of the markets. And this will require a good selection of charts and research resources. You need to be sure any broker you choose is offering as many as possible.
- Are there ways in which you can reduce your risk? There are risks involved with CFD trading, as with any form of investment, and it is vital these risks are kept to a minimum. Check whether the CFD provider offers a range of risk management tools, for example, guaranteed stop loss orders. A guaranteed stop loss is a great risk management tool to use as it safeguards your success, and is a way of controlling losses in volatile market conditions.
These are the most important questions to ask when looking for top rated CFD brokers. However, it is not all about finding the best CFD broker, but more about finding the top CFD trading brokers for you. One that ticks as many of your boxes as possible and is the one which suits you best of all. Maybe itâ€™s now time to introduce the CFD glossary, as weâ€™ve already introduced a few CFD trading terms you might be unfamiliar with.
|XM||$5000||CySec, FCA, BaFin||OR|
|Plus500||$10,000||FCA, CySEC, ASIC||OR|
|XM||$5000||CySec, FCA, BaFin||OR|
|Plus500||$10,000||FCA, CySEC, ASIC||OR|
Common terms used in relation to CFD trading simply explained
- Ask price – The quoted price a CFD broker or CFD dealer is willing to sell at. In other words, the price you will be expected to pay for an asset. It is also referred to as the offer price.
- Bid price – The quoted price at which a broker is willing to buy. In other words, the price you can expect if you want to sell an asset.
- Charts – These are used to plot price movements over a specified period of time. They are an important tool because they allow you to analyze how prices have risen and fallen and thereby forecast what will happen in the future.
- Close – This refers to ending your exposure on a CFD position. You wonâ€™t realize any profit or loss until a position has been closed.
- Expiry – CFDs have an expiry date and this is when your CFD will be closed and settled automatically. This happens at the end of the contract period.
- Leverage – Leverage is expressed as a ratio, for example, 10:1. Letâ€™s give you an example. Imagine you want to open a position with a $10,000 value. If leverage is 10:1 you will only need to put down a margin deposit of $1,000.
- Limit order – This is a target price set on an order and closes your position should the market hit the specified price. With a limit order, you can take your profit on a position automatically, as soon as your target price is reached.
- Long – When you buy an asset because you expect the price to rise.
- Margin – This refers to the deposit you pay when you want to open a CFD position. It should equal the amount you are prepared to lose on your position.
- New order – This is an order that will be opened automatically when an asset hits a specified price level you have set.
- No Dealing Desk – An NDD CFD broker automatically offsets your trades in the underlying market, and will never stand on the other side of your trade.
- Open – A position is said to be open when you buy or sell an asset.
- Pip – This term is used in CFD Forex trading and refers to one unit of the price.
- Point – This term is used in non-Forex markets and refers to one unit of price.
- Quote – This is the price offered for any asset and constantly changes as the market price of an asset changes.
- Requote – If a CFD provider is unable to open your position at the quoted price you will be given a revised price which is known as the requote. One reason this could happen is because the market price is moving very quickly. A number of the top CFD brokers will make a promise of no requotes.
- Rolling daily – This is when a position stays open from one trading day to another. Unless, of course, you decide to close the position. Holding a position overnight may incur a debit or credit.
- Rollover – This happens if you decide to extend your position beyond its expiry date. It will actually involve closing the old position and opening a new one for a revised period of time.
- Settlement – This refers to the profit or loss realized on individual positions.
- Short – When you sell an asset because you are expecting the price to fall it is known as going short.
- Slippage – During periods of high volatility and when prices are moving excessively, your broker may not be able to execute your stop-loss order exactly, and this is called slippage.
- Spread betting – This involves betting on the movements of financial markets and is another form of margin trading.
- Stop-loss – This is an important risk management tool and involves automatically closing a position when the price reaches a preset level.
- Trailing stop – This is a certain kind of stop-loss order and allows you to lock in your profit on successful positions. The stop-loss moves automatically in set increments when the asset is moving in your favor. But when the asset price moves against you it closes the position just like a normal stop-loss order.
So, there you have it. Some of the CFD trading jargon simply explained. How about we continue by looking at why CFD trading has become so popular.
CFD trading has received an explosion of interest in recent years
Trading in Contracts for Difference has become a very popular form of investment for a growing number of people. And those people come from some very varied walks of life. To cope with the increasing interest there has also been an explosion in brokers offering Contracts for Difference. But what are the advantages of CFDs for the average person?
- Higher return on investment – By betting on margin, CFD trading lets you open positions of much higher value than your initial investment. The underlying asset doesnâ€™t have to be purchased – CFDs are merely contracts between a buyer and seller relating to the value of an underlying asset. You will never need to have access to the actual exchange.
- No taxes in the form of stamp duty – Because you never actually purchase the asset there is no stamp duty levied on your trades.
- You get a bonus in the form of a dividend – A CFD mirrors the value of its underlying asset which means you get to receive all the benefits of owning stock. And if you hold a long CFD position when a company is making a payout you receive a dividend the same as a stockholder.
- You get to earn interest – When you have money tied up in a short position CFD you get to earn interest.
- You can make money when prices are falling – With CFDs, there is the opportunity to make money even when prices are falling, providing you predict the market movement correctly.
- Limit losses with a guaranteed stop loss – Trading in the markets is a very risky business and it is possible to lose huge amounts of money if you donâ€™t take the necessary precautions. One way of doing this is by using a guaranteed stop loss. Many of the best CFD trading brokers provide this option and it guarantees a position will be automatically closed once it reaches a reset price. Which in turn ensures no further losses are incurred.
- 24-hour trading – During the normal trading week, CFD trading can take place around the clock, even when the underlying assets market is closed. Which makes it a perfect form of investment for those who already have a full-time job.
- Wide choice of assets – Trading CFDs allows you to participate in a range of different markets. These include indices, commodities, currencies, stocks, treasuries, and sectors.
- CFDs have no expiry date – Contracts for Difference can last as long as you want them to. The only way to end them is to close out the contract and settle the difference.
All sounds pretty appealing, but what about the downside? There arenâ€™t too many disadvantages to worry about, but in the interests of providing all the relevant information, we should spend a few minutes sharing them with you.
- CFD trading is a very risky form of investment – We wouldnâ€™t be doing you any kind of favor if we let you believe CFD trading is a safe and sound form of investment. The risk comes with trading on a margin which leaves you wide open and at risk of losing far more than your initial investment. Consider the example weâ€™ve mentioned before where the margin requirement was just 10% of the investment. This makes it perfectly possible for you to lose ten times what you originally put down.
- CFDs can incur interest charges – When you trade on a margin your broker is effectively giving you a loan, and like any other lender you should expect to pay interest. This is one of the reasons many CFD traders choose to invest in the short term rather than paying interest on positions held open overnight.
- Guaranteed stop losses can be expensive – Weâ€™ve already mentioned that guaranteed stop losses can be seen as an advantage because they can be used to limit your risk. However, they can also be considered a disadvantage because they can be expensive and have a limited life.
So, do the disadvantages outweigh the advantages. It seems that for many people the answer is obviously no. We really canâ€™t comment as it is more of a personal thing and everyone will consider the pros and cons in different ways. The important thing is that we have given you both sides of the story so you are in a much better position to decide for yourself. If youâ€™ve weighed up the information weâ€™ve provided so far and still want to continue itâ€™s time for us to help with some tips and hints.
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CFDs explained – Tips and tricks to help you become a better trader
Do you know the golden rules of CFD trading? Are you confident you have what it takes to be a successful CFD trader? Are you worried whether there are any pitfalls you should avoid? Keep reading because weâ€™re about to share our top 10 rules you should follow:
Trade using logic not emotion – Using your gut feeling when making trading decisions is a sure fire way to lose in the long run. It may bring you a few profitable trades but this will be more a case of luck rather than judgment. Itâ€™s very unlikely youâ€™ll make consistent profits if you use only your gut feelings. Having a set of trading rules and following them consistently is the only real way to be successful.
Let profits run and donâ€™t be afraid to cut your losses – Cashing in too early or clinging to the hope of a losing trade changing direction are probably the biggest reasons traders lose money. The only result is going to be a series of small wins but an equal number of catastrophic losses.
Use fundamental and technical analysis – Using a combination of both types of analysis will stand you in a better position to become successful. As opposed to employing one or the other method. A good rule of thumb to follow is to use fundamental analysis to prompt the trade and technical analysis to influence your timing.
Donâ€™t be tempted to gamble it all on one single trade – Betting 50% or 100% of your trading capital on one single trade makes you a gambler. The sensible way to trade is to never risk more than 2% of your available capital on one single trade. This will ensure you donâ€™t wipe out your trading account with one bad trade.
Timing is everything – Donâ€™t be too quick to jump in and enter a trade too early. You might be right in predicting the long-term direction of the market, but this could still end up in you making a loss. The better approach is to wait for a trigger and at the very least one confirmation signal before entering a trade. And will ensure you donâ€™t enter too early.
Be flexible and consider diversification – Your aim should be to have a diversified portfolio, even if you never risk more than 2% of your trading capital on one single trade. Try and diversify across a range of instruments and markets if possible.
Donâ€™t add to losing trades – An important skill to learn is distinguishing between range bound and trending markets. This will mean you donâ€™t make the mistake of adding to a losing trade because youâ€™re expecting the price to turn around. One technique to use which will help this is to use trend lines.
Be wise in your use of stop loss – Weâ€™ve already mentioned that using a guaranteed stop loss is one way you can reduce the likelihood of a substantial loss. Not using a stop loss has the potential to wipe you out completely. However, be careful not to trade with a stop loss set too tight as this also has the potential to lead to a wipeout, although it will be a very gradual one. Leave enough space for the market to â€˜breathâ€™. In other words, leave space for the normal rise and fall in prices before the market heads in a certain direction.
Youâ€™ve all got weaknesses so itâ€™s important never to forget them – Greed and fear are two negative emotions which regularly trip traders up. Are you the kind of trader who can keep these emotions in check? Or would you be better looking for a way to limit this problem? You will be far more successful if you can learn to keep these emotions in check and not give in to them. One way to do this is by developing a trading plan and money management rules.
Do you understand risk versus reward – There is an inevitable trade-off between risk and reward and your success depends on understanding this. Never be tempted to enter a trade where the reward potential is bigger than the risk potential. An example of this is when you go long before the expected turning point in a range bound market. The expected profit, in this case, would be much smaller than the downward risk derived from the trade.
Make sure you use a well-defined trading strategy – Weâ€™ll be looking at CFD trading strategies in more detail a little later on. The important thing to say here is that it is important to have one and stick with it.
A good way to start your CFD trading experience is to open a demo account
If you like what youâ€™ve been reading and CFD trading is sparking your interest there is an excellent way to test the waters before trading for real. Most of the top CFD trading brokers offer the choice of a demo account, alongside live account options. Demo accounts arenâ€™t for everyone but we would highly recommend you take this important first step. It is the perfect environment for you to get to grips with the various trading platforms as well as help you develop your trading strategy.
How a CFD demo account can improve your trading success
Opening a demo account will give you plenty of opportunities to explore the different CFD trading platforms available, as well as try out various online CFD trading brokers before risking your own money. A demo account is designed to act as a replica of a live trading account, allowing you to trade live markets, and apply commissions and leverage costs like a real money account. The only difference is you will be trading with virtual money and any profit or loss will be for illustrative purposes only. But it will enable you to get a feel for the platform interface and help you understand how to place orders, set stops, and understand how to interpret live market data. Without a demo trading account, your initial mistakes could work out to be very costly. Demo accounts also help you to trade on real markets and try out different strategies and put them into practice. And you donâ€™t need to just open one demo account. A much better option is to open a few so you can get a broader feel for the markets, the different brokers and what they have to offer. Only by experiencing a variety of options will you be able to make an informed choice. However, we should point out a common mistake that traders make when opening a demo account. A common trap that many traders fall into is to take unrealistic risks or make decisions based on nothing more than a whim. Decisions they would never have made if they were trading with their own capital. To get the best from a demo account you have to treat it as real. This is the only way to get a reliable indication of whether your theory will work in practice. How about we finish up with a short history lesson. We think there will be a few of you interested in where CFD trading comes from.
A very brief history of CFD trading
Yes, we promise to keep it brief, as we completely understand history is not everyoneâ€™s cup of tea. We do, however, think itâ€™s important to give you a bit of a timeline so you can better understand how it all began. CFD trading is a relatively new concept, as it was originally developed just a few decades ago, in the early 1990s. CFDs were developed in London as a form of equity swap, traded on margin. What is an equity swap? Basically, it is a financial derivative contract with a set of agreed future cash flows that will be exchanged between two counterparties at a set date in the future. Two people are credited with its invention, both of whom worked for the UBS Group. The deal was set up on behalf of UBS by Brian Keelan and Jon Wood. The other counterparty to the deal was Trafalgar House Plc. Originally, CFDs were used by hedge funds and institutional traders to hedge their exposure to stocks on the London Stock Exchange. This was necessary because they required a small margin and no actual shares had to change hands. An added benefit was it avoided any UK stamp duty. CFDs were introduced to retail traders, in other words, ordinary traders like you. In the late 1990s and a number of UK companies helped in making them a popular form of investment by introducing innovative online trading platforms. This meant you could see live prices and trade in real time. GNI (Gerrard and National Intercommodities) was one of the first companies to offer such a service. IG Markets and CMC Markets came onto the scene in 2000 and helped to make such a form of investment even more popular. The initial reason for its popularity was the fact that any profits were exempt from tax. But by the year 2000, traders were starting to appreciate the ability to leverage any underlying instrument was even more appealing. CFD providers then began to expand their service to include not just London Stock Exchange shares, but indices, commodities, bonds, global stocks and foreign currencies. The most popular CFDs traded around this time were the ones based on the major global indexes such as NASDAQ, Dow Jones, FTSE, DAX, S&P 500, and CAC. It was soon realized by a number of CFD providers that CFDs had the same effect on the economy as spread betting had. The only difference being that profits from spread betting were exempt from UK capital gains tax. This led some of the CFD providers to launch spread betting services alongside CFDs. Because both markets mirror each other and the products are similar. However, spread betting has remained a UK and Irish phenomenon because of its country-specific tax advantage. Whereas CFD trading has expanded and is now offered in a number of other countries.The expansion started in Australia in 2002, but are now offered in a number of other countries such as Austria, Canada, Cyprus, France, Germany, Hong Kong, Poland, Portugal, Spain, Sweden and New Zealand. Hopefully, weâ€™ve answered a number of your questions, and provided you an insight, although only a brief one, into the world of CFD trading. Our aim is to keep you on track and give you all the knowledge you need to make it a profitable and exciting journey. Whether you are planning to trade CFDs on a part-time basis, or take it up as a full-time investment we will share all the information you need to make it a success. CFD trading is an exciting and enjoyable form of investing, but it does require time and effort. With our help, you will be well on the road to success. But ultimately the decisions are all down to you. We will provide you with the facts and then leave it up to you to decide which direction to take.