Share trading has always been around (at least during the last 150 years). Many institutional and retail investors spent their lives in trading financial instruments so I can say it is nearly a science. Today, any kind of trading is easily accessible and everybody with an internet access can start speculating on the markets. In this article I will explain how to take advantage of market movements by trading Contract for Differences for profit.
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What are contracts for differences
Contract for differences (CFDs) constitute an agreement between two counterparties, usually called a buyer and a seller. Each party agrees to pay the other party the difference in a price of an asset between two moments in time. For example if you believe that the oil price will rise in the next two days you want to buy a CFD based on Oil and close the deal after two days. If you guessed right the result will be the difference between the price you bought at and the price you sold at multiplied by the number of contract you bought.
Contracts for differences are based on various assets such as shares of stock, metals, currency pairs, oil, commodities, stock exchange indexes and basically on everything that is traded. A good article of what contracts for differences are explains the major benefits of trading those instruments instead of traditional shares trading.
Why trading Contracts for Differences?
CFD trading has many advantages compared to traditional shares trading. Of course there are cons too. Here I will try to just outline the major ones.
CFDs are traded on leverage. This means that you can purchase significantly more than you would on a stock exchange. For example a leverage of 100:1 will allow you to buy Apple shares priced at 5000 US dollars with just 50 USD available in your account. It is a double-edged sword though because it is easier to lose money quickly as it is easy to earn. If the price rises with total of 150 USD you will have earned 150 in addition to your 50. Conversely a fall of 50 USD will wipe out your account. Some brokers offer to trade CFDs on a leverage of 1:1 meaning you pay the actual price of an asset and thus having almost the same conditions as if you were trading on a real stock exchange.
Another major advantage of CFD trading is the lowered costs as opposed to stock exchange trading. When you open an account with a CFD broker you can usually place orders with minimum amounts of 1 contract, which is not possible on a stock exchange. The spreads and commissions paid for CFDs are significantly lower too.
However, the big difference between CFDs and real stocks is your counterparty. At the stock exchange you buy if there is someone to sell. It is a regulated market, so you and everybody know who’s selling to whom. The CFD trading falls into the category of OTC (Over-the-counter) market and in this sense you “bet” against the broker rather than buying assets. Although the CFD gives you almost the same rights as a shareholder, you do not actually own the shares. If the broker disappears you are left with the position against him and not owning anything anymore. Of course, this is an extreme example but you get the idea.
To minimize the risk, you should always choose a well-regulated and reputed broker so your funds and positions receive maximum protection.
How to trade CFDs on shares?
The best thing about CFDs is that you can either profit from rising and falling markets. Suppose you are interested in trading Apple shares. The first thing you need to do is to get informed about the company you are trading as well as to know more about the global economic situation. When you get an idea of how the price has been moving over the time it is time to test your trading skills. Of course, you don’t want to test using your real money so first open a demo trading account and see if you are doing well. If you believe the price will rise place a long order, conversely place a short one.
It is also important to get familiar with the platform you are trading with because sometimes you will have to think and act fast. I recommend at least one month demo trading before opening an account. After you have decided for you start with a small amount and try to never risk more than 2% in a single trade.
Major economic events influence all economies; so for example if there are bad news in China, your CFD will certainly go down. Make sure you understand the charts very well – they reflect the market, i.e. buyers and sellers behavior. In fact some traders say that 90% of their trading is based on what they see on the charts. This is not surprising because there is no better source of information of what is actually happening than the charts themselves.