Learn CFD Trading: Basic Tutorial for Beginners

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What is a CFD ?

A CFD stands for Contract for Difference (CFD). A CFD is a contract to buy or sell an underlying asset so as to profit from the price differentials over time, without owning or exchanging the asset itself.

All the buyer owns is a contract and not the physical asset. The contract can be a buy contract to profit from rising prices, or a sell contract to profit from falling prices. No exchange of any traded assets between the trader and broker is involved. The profits or losses are calculated using the price differential, the direction of the trade (buy or sell) and the trade volume (measured in lots).

What Assets Are Traded as CFDs ?

CFDs are grouped into asset categories. Therefore, the following assets are traded as CFDs.

  • Indices
  • Stocks
  • Commodities (energies, metals and agric-based assets)
  • Bonds
  • Cryptocurrencies

Each asset class Is different from the others.

Indices (singular: Index)

A stock index, or index for short, is a weighted calculation which measures the performance of a country’s entire stock market. A particular number of stocks is used to make up an index. The most popular stock indices traded as CFDs include US30 (Dow Jones), S&P 500, Nasdaq (US100), DAX (GER30), Nikkei 225 (Japan), Hang Seng (Hong Kong) and FTSE 100 (UK). Which index is composed of a composite weighting of the listed stocks. the performance of each stock determines the final value of the index.  The stocks with heavier weighting have a greater effect on the overall value of the index.

Stocks

The stock is the unit that measures the percentage of ownership of a company that is listed publicly i.e. listed on a stock exchange. The price of a stock changes with the demand on that stock as well as the sentiment around the stock. Whatever causes money to flow in or out of the stock determines his final price at any given time.  Due to the number of stocks available for trading on many exchanges around the world, stocks are the largest CFD class.

Commodities

Commodities Follow divided into three categories:

  • Energies: crude oil, natural gas
  • Metals: gold, silver, copper, platinum, etc.
  • Agro-based: coffee, cocoa, sugar, wheat, corn.

Commodities are the most volatile CFDs and respond heavily to the state of the global economy,  since many of them form the feedstock to many industries. They also have a lot of domestic usage.

Bonds

Bonds are derivative assets based on debt. These debt instruments may be used to borrow funds and are usually issued by governments or companies. The most popular bond CFDs are those based on US and German government bonds.

Cryptocurrencies

This is a relatively new CFD class. It features the top cryptocurrencies such as Bitcoin, Litecoin, Ethereum, Ripple, Monero, Bitcoin Cash and Dogecoin. They are marked by low leverage and high spreads. They are the most volatile CFD class and should ideally not be traded by beginners or traders without experience.

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More Details >> Top CFD Trading Brokers

Characteristics of CFDs

What are the peculiar characteristics of CFDs?

  • CFD trading is leveraged. In the EU/UK, leverage on CFD trading is set at 1:5 for cryptocurrencies, 1:10 for volatile CFDs, and 1:20 for non-volatile CFDs.
  • The price of every CFD asset is the same as the underlying market. If Apple is priced at $500 per share on the Nasdaq, this is the same price you will see on your trading platform.
  • CFD trading allows the trader to profit from bi-directional movement. You can profit from rising prices or falling prices using long or short orders respectively.
  • Trading volumes in CFD trading is measured in lots.
  • CFD trading attracts interest for holding positions overnight.
  • All price quotes for CFD assets are in pairs. There is a bid price (price on the left) and an ask price (price on the right). The difference is the broker’s compensation.
  • CFD trading is banned in several countries such as the US.
  • Some CFD contracts expire in 1 month or 3 months, after which the positions are closed and trades settled in profit or loss, depending on the entry and exit price as well as the trade direction. Some platforms now offer continuous contracts.
  • Every CFD category or asset class has its own unique contract specifications.

Advantages & Disadvantages of CFD Trading

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CFD trading has its disadvantages and advantages.  it is important to know them so that you know how to use the advantages to your benefit and also avoid these advantages.

What are the advantages of CFD trading ?

a) Cost

It is cheaper to trade many assets as CFDs than in their conventional markets.  For instance, if you are trading commodities, trading them as CFDs is much cheaper than trading them in the commodity exchanges such as CME, NYMEX, COMEX or London Mercantile Exchange (LME).

b) Convenience

Taking physical delivery of an asset comes with other obligations such as transportation and storage, which can make the process very expensive and inconvenient. If you are a retail trader with small capital, this option is not tenable. In these cases, CFD trading provides a convenient way to trade such assets, benefitting from the price differentials without the extra obligations involved in transporting, storing and securing the asset. This brings convenience to the retail trader.

c) Leveraged Trading

CFD trading is leveraged, which allows the trader with small capital take on larger positions and keep any profits in the same order as if he had the larger capital in the trade.

d) Greater Access to Markets

CFD trading provides access to thousands of assets spread across the globe. Therefore, you have the chance of trading a market with potential from a single account, wherever that market is situated.

What are the disadvantages of CFD trading?

  • Risky

As you do not own the assets you are trading, it is possible for your position to lose all of its value, leaving you with nothing. This is not like trading the conventional markets where you can hold on to the assets until prices recover. In CFD trading, the price and value of your position and get down to the zero, leaving you with a total loss.

  • You Can More Than Your Capital

If there is excessive slippage in the market, it is possible that the stop out and margin call mechanisms set to protect the broker’s capital used in the leverage can fail and place the trader’s account in the negative if the losses are huge.  In the EU and UK this problem is being tackled as regulators are requesting brokers to provide negative balance protection.

  • Excessive Leverage

Some brokers allow traders to use excessive leverage which can ultimately decimate their trading accounts if they suffer a sequence of losses.

What Affects CFD Prices

Prices of CFDs are affected by the fundamentals of each asset class. These fundamentals are as follows:

Stocks:  the fundamentals are the stock prices include earnings reports,  development of a new product,  appointment of a major industry player into the top management positions of a company,  all news that affect an entire sector in which a stock  is lifted.

Commodities:  the fundamentals of commodity prices are those events or news which affect the demand and supply of a particular commodity. No two commodities have the same fundamentals except those commodities are linked. For agro-based commodities factors such as adverse weather patterns, natural disasters, crop disease outbreak or political situations which affect supply, can all affect prices. Metal and energy commodities are more affected by the health of the global economy as it affects the demand for those commodities. For example, COVID-19 affected the demand for risky commodities, and the prices of copper and crude oil collapsed. For energy commodities, the production quotas as determined by OPEC also plays a role in price determination.

Cryptocurrencies: The fundamentals of cryptocurrency prices are usually the signing of partnerships that have the potential to increase the adoption and usage, as well as demand for a particular cryptocurrency.  Also, the price direction of Bitcoin tends to dictate the price direction of correlated cryptocurrencies such as Litecoin, Ethereum, Bitcoin cash and Ripple.

Bonds:  Bond yields are linked with bond prices and interest rates, especially in the United States. Interest rate decisions or policies that have the potential to impact interest rates as directed by the Federal Reserve, have the potential to affect bond yields and bond prices.

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Risk Warning: Trading CFDs is a high risk activity and you may lose more than your initial deposit. You should never invest money that you cannot afford to lose. FXDailyReport.com will not accept any liability for loss or damage as a result of reliance on the information contained within this website including data, quotes, charts and buy/sell signals. Please be fully informed regarding the risks and costs associated with trading the financial markets.