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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.
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 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/cfd-trading-tutorial.php
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