- Contract for differences (CFDs) are types of derivatives that allow traders to speculate on the price movement of stocks, commodities, and indices. They are traded over the counter (OTC) with an established broker.
- Brokers offer leverage on CFD trading so you can trade with less money than using traditional trading methods.
- CFD trading allows for 24-hour access to markets globally during business days.
What are CFDs?
CFDs are financial instruments that allow traders to speculate on whether the price of an asset will rise or fall without actually owning it. CFD trading is possible because CFDs are based on contracts between two parties. One party agrees to pay the other party if the price moves in their favour. Investors can trade CFDs of everyday stocks, metals, indices, and similar securities.
The benefits of trading CFDs
Unlike share trading, where retail investors don’t have easy access to leverage and international markets, CFDs are often traded with tools that make them more attractive for certain investors. Leverage is a standard tool of CFD trading. It allows investors to potentially keep higher profit margins by increasing the exposure of the trade. Then, CFDs usually don’t expire in the same way as options and similar contracts. Traders have the ability to trade 24 hours a day with direct market access and flexible position sizes. Also, this type of trading should be reported on your tax revenue in accordance with Australian tax laws. This means that you can deduct any potential losses against your tax bill.
CFD trading leverage
Leverage allows investors to profit from price movement using a smaller amount of capital. Opening a position with a leverage of 10:1 means that a CFD trader will only need to put down 10% of the amount of money required to open a certain position. If their speculation of the price movement is correct, they get to keep the profits generated from the full size of the trade. Traders with $5,000 invested in CFDs can trade on the same level as someone who invested $50,000. In this case, you can have the same exposure as someone who has 10 times the money to invest. However, theoretically, leveraged losses are not capped to the invested amount. Traders with exposure to leveraged assets can lose more than the initial deposit if their speculation happens to be wrong. They can also deplete their accounts much faster. Therefore, it is best to stay cautious when trading with leverage. Brokers are aware of potential market volatility, and some provide safety features to prevent traders from incurring additional losses. For example, traders may receive a margin call, urging them to fund the account or liquidate some of the assets to retain enough trading capital. Additionally, brokers may close positions to prevent slippage. Both of these examples happen when there is not enough money in a trader’s account to sustain further losses. Here at Rakuten, we provide Negative Balance Protection for Retail Accounts but let Professional accounts deploy more sophisticated trading strategies. Negative Balance Protection will close your position if there is not enough money in the account, protecting you from losing more than your initial investment. Professional accounts do not have this feature as we believe professional traders have robust experience and deep market knowledge that makes them eligible for additional benefits.
No fixed expiry date
CFD trading has no fixed expiry date because CFDs trade like any other securities with buy and sell prices. Unlike options, traders can hold both long and short CFD positions for as long as they can fund the position. On the other hand, options are securities with a strict expiry date. When the target date arrives, the contract can lose all of its value if it does not reach the target price.
Direct market access
Direct Market Access (DMA) is an attractive feature because it is the CFD trader’s equivalent to standing in front of the NYSE and trading on-site. Rarely anybody trades securities on the stock exchange floors nowadays. It’s mostly a relic from the past. However, exchange pits and floors are places of instant transactions between parties. Sellers and buyers are lined up, and liquidity is rarely a problem. DMA enables CFD price and liquidity to mimic the underlying security in real-time. If you are buying Gold CFDs, you are paying the same market price as if you were purchasing the gold itself. You are also buying and selling at the same pace as you would if you were buying the precious metal.
Flexible position sizes
CFD traders can use flexible position sizes and leverage to invest less capital while reaping the same rewards and risks as traditional investors. Flexible positions are what make CFD trading convenient for traders on all levels. Traders can open an account with Rakuten Securities Australia and start trading for only $50. Then, if your capital grows, you can adjust your leverage and position accordingly.
How to trade CFDs
Every trader should carefully consider their investment objectives and the amount of risk tolerance before they start investing. CFDs are typically used for trading on global markets that would be otherwise difficult to access for everyday traders. For example, you can buy and sell CFDs for assets such as indices, shares, and metals. When opening a CFD position, traders are presented with two options. First, they can go long. Traders who go long on a contract are betting the underlying asset will increase in value. If an underlying asset price increases, the trader can close the position and take profits. Going long is also referred to as executing a buy order. Second, traders can short contracts for difference. This instrument lets traders sell something they do not own because they think it is going to decrease in value. If the asset falls, traders can then buy it at a lower price, return the contract, and make money from the price difference. For example, you could sell a CFD contract for $100 and repurchase it later for $90, pocketing the difference as profit. This is also called short selling.
Asset price
Entry prices may slightly differ from the original asset price. This is because brokers offer ‘Bid’ and ‘Ask’ prices. They typically differ a few points from the underlying asset price. Brokers can utilise Bid and Ask prices to remove trading fees that are common with classic share inventing. Bid and Ask prices make up for financial service, broker risks, and trading expenses.
- If the trader closes the position while it is 11% ahead, he will keep the entire profit as if he was trading $73,100. He will be able to add $8,040 to his account.
- Alternatively, If the market turns against him and his position suffers a loss, he can close his trade and only pay the losses incurred up until then.
- The trader’s total loss is the maximum of the sum invested in the Australia 200 CFD index position, if he has not invested any more money in his account. He cannot lose more than $3,655, as our Retail accounts protect our traders from slipping into negative balance.
Bottom Line Contracts for differences are a practical and straightforward way of trading securities. They are a type of derivative that allows traders to profit from movements in prices while minimising risks that come with ownership of an asset. Brokers offer CFDs at Bid and Ask prices, which usually differ only a few points from the underlying asset price. Bear in mind that every investment carries financial risk. The same is true for trading CFDs. This is why we recommend opening a demo account while learning how to navigate international markets. Demo accounts are perfect for beginners because they can get all the actions of live trading without risking their personal money. Opening a demo account is free and is highly recommended before seriously starting with CFD trading.