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LEARN TO TRADE CFDS // HIGH LEVERAGE, LOW MINIMUM CAPITAL,
INSTRUMENTS FOR SHORT TERM TRADING.
- What is CFD Trading01
- Key Features of CFD Trading02
- Take Both Long and Short Positions03
- Calculate Profits and/or Losses04
- CFD Trading Examples05
- Key Benefits of CFDs06
- Margin Obligations07
- Risks of Trading in CFDs08
- Styles of CFD Trading09
- Tools & Resources10
- How to Open an Account11
- Supported Brokers12
Introduction to CFD Trading
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1. What is CFD Trading?
CFDs are ‘over-the-counter’ (OTC) derivative contracts. This means that they are created and traded off-market between parties rather than on an exchange, such as a stock exchange or futures exchange.
WHO TRADES CFDs
2. Types of CFDs
CFD Brokers offer Share CFDs, Index CFDs and Expiring CFDs. Not all CFD Brokers or platforms have Share CFDs, for example, you cannot trade Share CFDs on MT4. TradeWise will help you select the correct CFD Broker for your chosen trading products.
You can enter into CFDs based on shares listed on international exchanges. These CFDs are referred to as Share CFDs. Share CFDs derive their price from real-time fluctuations in the exchange-traded price of the Underlying Security on which the Share CFDs are based. For example, if you bought 1000 Share CFDs and the price of the Underlying Security was quoted as 25.70/25.71 then the Share CFDs would have a “notional value” or “contract value” of $25,710 (being 25.71 x 1000). This example is provided included for illustrative purposes only. Prices for Share CFDs are only quoted and can only be traded during the open market hours of the relevant exchange on which the Underlying Security is traded. Open hours of the relevant exchanges are available by viewing the relevant exchange websites.
DIRECT MARKET ACCESS VS MARKET MADE SHARE CFDS:
There are thought to be two models or ways of trading Stock CFDs. The first is via what is commonly known as, the Direct Market Access (DMA) Model. The second is via what is commonly known as, the Market Made Model. The terms, however, are a misnomer as all CFDs are Market Made by your CFD Broker by the very nature of being an OTC product. DMA versus Market Made is simply a reference as to how your CFD Broker handles your transaction i.e. do they hedge your trade on an exchange or do they warehouse your trade on the brokers own book. Our experience would suggest that brokers who offset you trade on an exchange have given better pricing, but in reality, even DMA CFD providers may still choose to act as counterparty to your trading, as opposed to offsetting their risk on your position through their liquidity supplier, prime broker or exchange, particularly if you have a history of being an unprofitable trader.
MARKET MAKER MODEL
STRAIGHT THROUGH PROCESSING, DEALING DESK, A-BOOK AND B-BOOK:
Straight Through Processing (STP), Dealing Desk, A-Book and B-Book are terms used commonly by CFD Brokers and Educators. For your benefit these terms are described below:
STRAIGHT THROUGH PROCESSING (STP)
KEY FEATURES OF CFDS:
The key features of CFDs are as follows:
CFDS AND THE UNDERLYING PRODUCT ARE CLOSELY ALIGNED
NO REQUIREMENT TO OWN THE UNDERLYING SECURITY
OTC PRODUCTS ARE NOT STANDARDISED
CFDS AND THE UNDERLYING PRODUCT ARE CLOSELY ALIGNED
3. Take Both Long and Short Positions
With CFDs you can take either direction when entering a transaction or trade.
4. Calculating Profits and/or Losses:
This example is included for illustrative purposes only, and is not indicative of actual exchange rates or values.
- You purchase 1,000 Share CFDs (i.e. you enter into a “long” CFD) where the Underlying Security is an ANZ share and the price at which you enter into the CFD is $32.71; and
- You later Closed Out the CFD by “selling” (or entering into a “short” CFD) at a higher price of $33.31.
The resulting gross profit on the transaction would be $600 being sale price ($33.31) less buy price ($32.71) x 1,000.
The net profit is determined after deducting commission, funding charges, transaction costs and any other charges.
The impact of fees on the net profit realised will be dependent on many factors and in particular, the length of time the open position was held as the funding charge is applied daily.
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5. CFD Trading Examples
We have described how CFD Transactions work and the basic points of CFD Trading.
One of the key advantages CFDs has over other financial instruments is that relatively small lot sizes can be traded – lot sizes can be as small as 1 unit (one share or one dollar per index point).
A CFD Contract is an agreement between two parties to make payments to each other based on changes in the value of one or more pre-agreed assets (Underlying Product), for example changes in a stock index, a commodity or an equity. The amounts you may have to pay, or the amounts you may receive, are calculated by reference to differences arising from movements in the value of the Underlying Product.
6. Key Benefits of CFD Products
CFDs provide a number of benefits which must be weighed against the risks of using them. The benefits of CFDs are as follows:
PROFIT POTENTIAL IN BOTH RISING AND FALLING MARKETS:
LOW STARTING CAPITAL REQUIREMENTS
TRADE FROM ANYWHERE
7. Margin Obligations
CFDs are subject to margin obligations i.e. you must have sufficient balance in their Trading Account for security and margining purposes. You are responsible for meeting all margin payments required by your CFD Broker.
TYPES OF MARGIN
In order to enter into a CFD Transaction you will be required to pay your CFD Broker the Initial Margin or have an amount of Net Free Equity in your Trading Account that is at least equal to the Initial Margin. This amount represents collateral for your exposure under the transaction and covers the risk your CFD Broker takes on you.
Depending on the particular CFD Transaction, the market volatility for the Underlying Product and the Trading Platform you use, the Initial Margin for a CFD Transaction will typically be between 1% and 30% of the face value or contract value of the CFD Transaction. However, it is not uncommon for Initial Margins to be above this range.
Margin Requirements differ depending on the Trading Platform you choose. In choosing a Trading Platform, you should carefully consider the Margin Requirements of each Trading Platform as Margin Calls could have an adverse impact on your investment.
Your CFD Broker may, in their sole discretion and without the need to notify you, change the percentage Margin Requirements for a CFD Contract from to time. You should refer to the Initial Margin schedule on your Trading Platform for more information about the Margin Requirements each time you enter into a CFD Transaction.
As the value of your CFD will constantly change due to changing values of the Underlying Product, the Margin Requirement (being the minimum Trading Account balance you must maintain in order for your CFD Broker not to Close Out some or all of your CFD Transactions) on the open positions will also constantly change. This is also commonly referred to as a Variation Margin. The amount of your Margin Requirements (being the Initial Margin and any adverse Variation Margin) at any one time will be displayed on the open positions report made available through your Trading Platform.
Any adverse price movements in the market must be covered by further payments from you (unless you already have sufficient “Net Free Equity” in your Trading Account). Your CFD Broker will also credit the Variation Margin to your Trading Account when a position moves in your favour.
Your CFD Broker determines the Variation Margin for a CFD Transaction by reference to changes in the value of the Underlying Product. In other words, each contract is effectively “marked to market” on a real-time basis. “Marked to market” means that an open position is revalued generally in real time or at least on a daily basis to the current market value. The difference between the real time/current day’s valuation compared to the previous real time/day’s valuation respectively is the amount which is debited (in the case of unrealised losses) or credited (in the case of unrealised profits) to your Trading Account. The valuations are calculated using the closing value (at the close of trading on each day) of the Underlying Product as determined by the relevant Pricing Source. Intraday “marked to market” revaluations will be based on the last available value of the Underlying Product as determined by your CFD Broker in their sole discretion.
Your CFD Broker will attempt to provide you with notice of any adverse Variation Margin by making a Margin Call (via ‘pop-up’ screens or screen alerts on the Trading Platform).
It is your responsibility to monitor your Variation Margin obligations. Any notification of a Margin Call will be via a ‘pop up’ screen or screen alert which you will only receive notice of if you access your online Trading Account via your Trading Platform’s website. There may be instances where your CFD Broker does not provide you with a Margin Call notifying you of an obligation to meet a Variation Margin. This does not waive your obligation to meet that Variation Margin. If you fail to meet a Variation Margin your CFD Broker may in their absolute discretion (but without an obligation to do so) Close Out, without notice, all or some of your open CFD Transactions.
Margin Calls are made on a net Trading Account basis i.e. should you have several open positions with respect to a particular Trading Platform, then Margin Calls are netted across the group of open positions. In other words, the realised and unrealised profits of one CFD Transaction can be used or applied as Initial Margin or Variation Margin for another CFD Transaction.
FAILING TO MEET A MARGIN CALL
If you do not meet Margin Calls immediately, some or all of your positions may be Closed Out by your CFD Broker without further reference to you.
Your CFD Broker generally applies risk limits (referred to as Default Liquidation Thresholds) to ensure that the percentage of your Trading Account balance which you are using at any one time to satisfy Margin Requirements (Margin Utilisation) does not exceed certain pre-defined levels. If your Margin Utilisation exceeds the Default Liquidation Threshold for your Trading Platform, a Margin Call will generally be applied to your Trading Account. If you do not meet a Margin Call immediately, your CFD Broker may Close Out some or all of your open CFD Transactions without notice to you.
The Default Liquidation Threshold is determined by the CFD Broker for your Trading Platform. It is implemented for risk management purposes, and may be varied by the CFD Broker at any time.
If you fail to meet a Margin Call, then your CFD Broker may in their absolute discretion (but without an obligation to do so) Close Out, without notice, all or some of your open CFD Transactions and deduct the resulting realised loss from your Trading Account. You may be required to provide additional funds to your CFD Broker if the balance of your Trading Account is insufficient to cover these losses. If a Close Out occurs you will not be able to enter into another CFD Transaction until you transfer additional funds to your CFD Broker.