• CFDs - What you need to know

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With CFDs;

1. You don’t pay the full or face value

2.  You pay margin or deposit

3. You buy or sell in any order

4. You don’t take delivery 

Size of the market

In Australia it is estimated that Shares CFDs account for between 10 – 15 % of turnover on ASX. When you consider the many other products over which CFDs are also available such as currency, commodity and international equity CFDs the market is much larger.

CFDs first came to Australia in early 2000 with UK based CFD providers such as CMC Markets, IG Index offering CFDs. Today both companies are amongst the biggest and most established players offering CFDs over a range of different instruments.

Next were the Direct Market Access providers such as MF Global, First Prudential Markets. These companies specialise in CFDs over ASX listed stocks.

In 2008 the ASX itself listed CFDs on its exchange.


Why use CFDs?
An alternative to shares, futures contracts or trading currency in separate accounts with different providers CFDs are usually available over all these instruments from the one account. This makes life easier and reduces the amount of capital you need to trade a variety of products. In terms of the product itself CFDs are traded for speculative reasons as well as to as a hedge.  The fact they are leveraged instruments requiring only a small outlay makes trading easier still.

Reasons why people use CFDs

·          Wide range of different markets available to trade - currency, commodities, overseas equities, bonds etc.

·          Leverage( A margin of 5 % equates to 20 x leverage or a $5K deposit controls $100K position)

·          Low transaction costs

·          Short selling

 
Types of CFDs

In the world of CFDs like any other product there are variations. Some CFDs are contracts created by the CFD provider, others are the result of a trade in the underlying shares on the exchange after which the CFD provider creates a CFD contract and in the case of listed CFDs they are traded as a CFD from the outset on the exchange.

 1. Contract with a CFD provider

  

mp;nbsp;     ·          The most common type of CFD contract
        ·          Is not traded on an Exchange

2.  Direct Market Access CFDs

       ·          Created by the CFD provider directly from a trade on an Exchange

3.  Listed or Exchange Traded CFDs

       ·       A CFD contract traded on an Exchange.

Choosing a CFD provider
The CFD provider you choose will be based a variety of factors including dealing costs, products available to trade, and your confidence in them.

1.     Dealing costs include commissions, spreads, and interest charges.

2.     How many products are on their platform and are they of interest

3.     How quickly do they respond to your questions, how reliability is their trading software, do you they assist with trading ideas, education to get you  started and you improve your profitability understand   and how well capitalised are some of the factors they are as well as range of other factors.

Order types

CFD providers some of the widest range of order types. They have the ability to do this because they are not passing your orders thought to an exchange. This means they are not restricted with the type of orders they can offer as is the case with trading on an exchange.

Different order types and the ease with which they can be adjusted or set to automaitically move up or down ( trail ) prices is a very big plus with CFDs.

There are the standard order types  but others include orders to enter a market above or below the current price known as stop entry orders. Orders to cancel one leg of an order when the other side of the order is executed known as “one cancels the other” allow orders to be entered without fear of trading twice when the intention was to either make a profit or stop a loss. And  guaranteed stop loss orders that close a position regardless of whether the price trades at that price or not are not usually available when trading in the stock market.

The terminology may be slightly differently depending where you  trade but the range of order types is an important point to consider when choosing where to trade.  You profitability will definitely be impacted.

Risk management
Remember the good but don’t forget the bad! Pay no attention to risk and you will be out of the game faster than you imagined possible. CFDs are leveraged so your account can control positions many time s larger than the cash balance.

Management of risk takes many forms.  Correct position sizing relative to size of your account, use of stop loss orders, spreading one position against another , and a knowledge of what you are trading.

Failure  to take account of risk when trading leveraged products like CFDs can be fatal. 

Margin

The amount required to hold a position and varies considerably between products. The more liquid and underlying market – FX for example – the lower the margin will be.  A couple points to note about margin.

•       Insufficient margin and your positions will be automatically closed.  
•     A deposit required to establish a position
•       Must be maintained or the position closed
•       Minimum margin = Minimum intelligence

Summary

If you’ve made it this far you should have a pretty good idea about what CFDs can do. The ability to go long( buy ) or sell (go short), multiple order types to take advantage of markets that range or explosives moves up or down, a wide variety of instruments and all with low transaction costs no typically seen in other markets.

So now the search begins for a CFD provider. In some cases one will suffice in others you may decide to open accounts at several as their will probably be advantages in using different CFD providers for different products or at different times.

Clive Tompkins
Finance News Network