You need to make money money whether the sharemarket is trending up or down, and CFDs can help you to do this.
Keep reading to get your head around how these tools work, so that you won’t be a sharemarket victim when the market drops. Don’t get left behind! There’s money to be made. Louise and Chris will guide you every step of the way.
What the heck is a CFD anyway?
Before you trade these little beauties, you’d better fully understand what they’re about and how they can work for you.
Within the field of trading there have been many standard products such as shares, options or futures. Within these instruments there have been a subset of instruments that have been tested and which have failed to capture the imagination of traders. Tools such as share ratios, single share futures, index and currency warrants are among those instruments which have failed to thrive.
Contracts for Difference (CFDs) have had a vast impact upon the mind set of traders. Originally a tool designed to facilitate foreign investment, CFDs have become part of the modern trader’s arsenal and are now as much a part of trading as shares or exchange traded options. In fact in the year 2003 the trading of CFDs in the UK outstripped the trading of ordinary shares for the first time. Things have only improved from there, and the majority of full-time traders rely on CFDs to fuel the returns they make on the sharemarket.
A CFD is a ‘Contract For Difference’. As a trader, you have a contract with a market maker whereby you agree to settle the difference between the price you purchase the contract at and the price you sell it at. Conversely if you were a short seller you would have to settle any difference between the point at which you sold your contract and the level at which you bought the position back in cash. Even though they sound a little complicated, keep reading, because you’ll love the profits that can be revealed by these nifty little tools.
All CFD trades are ‘margin trades’ – that is you simply put up a portion of the actual value of the trade. In most instances this is 10% of the total value. For example if you bought $100,000 worth of BHP, CFDs you would only need to put up $10,000 or 10%.
There is no physical delivery of a CFD contract so they cannot be exercised in the same manner as an options contract. Nor do you have any of the ancillary benefits of owning a share such as attending the Annual General Meeting and eating the Tim Tams they generally provide there. However, you do participate in dividends and any corporate actions such as bonuses.
All CFD trading is settled in cash. Money either flows into or out of your account, depending upon the success of your trading.
What can I trade?
CFD providers allow the trading of a wide array of markets both domestic and foreign. At present trading is permitted over the following instruments:
- ASX 300 shares, this depends upon the provider
- S&P 500 + NASDAQ 100 shares
- UK FTSE 350 + constituents of all major European indices
- Foreign Exchange including all major cross rates + a selection of minor and exotic cross rates
- All major share indices
- Options on major share indices
- Gold and Silver
- Various commodities such as corn, soy based products, coffee, oil, etc
‘Buy and Hold’ investors are dead in the water
Anyone who just thinks that they can profit by buying a share and hang in for the long term is kidding themselves. Let’s look at an example about how a CFD trade might work for you. Have a look at the following chart of ANN:
In this example the decision to trade is based upon the double top and the failed ascending triangle acting as a set up with the trigger being provided by the rejection move and the ensuing gap down. These types of patterns not only impress your friends at dinner parties, but they can also help guide you into opening a trade with precision.
So, in our hypothetical example we go short ANN at $7.00. To ‘go short’ means to open a position by selling initially, and then hopefully buying the position back when the price has fallen. If the trade goes according to plan, the price will plummet and you’ll make a tasty little profit.
Notice that we then have a reversal signal where price gaps strongly against our position, so we exit the trade at $5.50. This trade yields us a profit of $1.50 per share.
How to decide on a CFD provider
CFD providers generally fall into one of two business models that revolve around how they set the prices at which you deal – transparent pricing and spread pricing.
The price of each of the quoted CFDs can reflect the cash price of the underlying. For example, if the ASX quote for BHP is $11.00 buyer and $11.02 seller, then this is referred to as the cash price and the CFD provider will quote exactly the same price.
This approach to quoting is common among CFD providers who will charge you a commission each time you trade and is referred to as a transparent model.
The second feature to note about such a model is that the quotes are referred to as being two-way quotes. For example, let’s assume that I wanted to trade a share that was quoted $0.50/$0.51 and I wanted to buy 10,000. I go ahead and place my buy order at $0.51 and the order is filled, I am then struck by one of those moments of terror that can afflict traders and I realise that I have bought the wrong share so I desperately need to reverse the position. I sell out of the position at $0.50 and I wear a $0.01 loss for being careless. Such a situation is only possible because of the so-called ‘two-way’ basis of quotation.
Some providers do not provide quotes on such a basis and would re-quote you a differing spread of perhaps $0.48/$0.49 thereby allowing them to profit from your error.
The second method of pricing involves the CFD provider quoting you a price to deal that is different from the cash or underlying price. Such firms make their money not by charging you a commission, but by charging you an ‘all in’ spread that is reflected in the prices you are offered to deal at.
For example, the cash price of a BHP may be $11.00/$11.02 whereas the price quoted by the CFD provider may be $10.95/$11.08. The difference between the two prices represents their spread. The easiest way to imagine this is to think in terms of travellers cheques. If you have ever bought travellers cheques you will know that the price the bank sells them to you at is higher than the price they will buy them back from you. The spread in between is their profit.
There are a few concerns with such a pricing mechanism. The first is the cost of doing business is not known in advance. Secondly the quotes provided are not two-way quotes. If you wish to turn around and sell the position a few moments later you may be subject to a re-quote that does not reflect any change in the cash price.
CFDs are a highly leveraged product and this leverage can be overly attractive to inexperienced traders. Many naive traders approach CFDs in the belief that all they have to do is deposit $10,000 into their account and then buy $100,000 worth of NWS with the hope that it goes up 10%. What generally happens is that NWS loses 15% and they end up losing their initial investment, plus they owe the CFD provider an additional $5,000.
However, if you’ve already nailed the basics, and your trading goes well, CFDs can be your own private gold mine! You can literally sky-rocket your returns. Just make sure you’ve got a sound and tested trading plan that includes rules for entry, exit and position sizing.
Take the guesswork out of CFDs
We’re often asked, who is the best broker to trade CFDs through. Click here for more information about our favourite brokers.
So, if you’re keen to learn more about CFDs, you need to turn to experienced traders who have the knowledge, experience and cutting edge techniques to help drive your account into profit. Chris Tate and Louise Bedford are among the best in the business, and have several products focussed on CFDs.
Some Products to Kick-Start Your CFD Career
Dive headfirst into the world of CFDs and see how other traders are taking control of their own equity. This triple CD set is designed to take you by the hand into the world of CFDs. Click here to read more and take the next step.
Where’s the Money?
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