What is a CFD?
Contracts For Difference (CFDs) are specialised and popular Over The Counter (OTC) financial derivative products which enable you to trade on the price movement of financial assets Indices Futures, Commodity Futures, Cryptocurrency, Shares and Exchange Traded Funds.
They enable clients to trade freely without actually owning the underlying asset or acquiring any rights or obligations in relation to the underlying asset. The main benefit of trading CFDs is the flexibility to trade against the price movements without actually buying or selling the physical instrument.
AvaTrade’s CFDs derive their price from the underlying asset. You can trade CFDs if you believe the price of a financial instrument is likely to go up in value (strengthen) and if you think it is likely to go down (weaken). Your profit or loss in online CFD trading is determined by the difference between the price you buy at and the price at which you sell.
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Introduction to CFDs
CFD Trading Methods
There are various trading strategies that are often used when trading CFDs, that even the most unskilled trader can understand. These decisions involve a number of trading methods and the most popular are the Long vs. Short
- Long Position
A long position in trading CFDs is when a trader purchases the asset. This will mean that the asset will rise or see an increase in its value over the time of life of the contract. In long term trading, as it has a higher level of forecasting ability will allow traders to act on lower price market moves. Trades normally last from month to more than a year.
- Short Position
The short position occurs when the trader feels there will be a decline in the assets value and a ‘sell’ is selected, however there is an intention from the trader to buy the contract back at a later stage. E.g.: A short seller’s expectation is that the price of the asset will fall over the life of the contract. If his prediction is wrong and the price of the asset starts to rise the open trade will sustain a loss, which is calculated by the difference between the opening and closing price of that asset over that time. The reverse is true should his open trade indicate that the asset chosen would decrease in value. Short term trades can allow profits from short time spans even up to minute-to-minute moves. Limiting financial costs is an advantage in short term trading.
This would be a happy medium that offers both undated futures and contracts and can be traded on short or long term CFD strategies.
Trading CFDs in 2020
Coronavirus (Covid-19), the realisation of Brexit, interest rate cuts, trade wars… the global financial markets started 2020 on a rollercoaster! The prices of the most popular financial assets have been rising and falling rapidly and extensively since the beginning of 2020. While large-scale investors are concerned with how to protect the value of their portfolios against unstable market conditions, Forex and CFD traders are overjoyed with numerous opportunities emerging every day.
AvaTrade traders are certainly among the leading market players who made the most out of it. By choosing to trade CFDs with AvaTrade, they continued to benefit on price changes and didn’t have to worry about the value of a physically owned asset. Taking advantage of AvaTrade’s competitive spreads and high leverage in a wide range of financial assets, including cryptocurrency pairs, our traders can trade CFDs in a secure environment with top regulations in 5 continents.
After over 14 years of experience, multi-award winner AvaTrade is still the #1 choice of the Forex traders by offering the best CFD trading conditions, world-class customer service, and free educational resources.
Why Trade CFDs with AvaTrade?
As one of the pioneers of online CFD trading, AvaTrade serves as a compass to Forex and CFD traders as they navigate through the realm of financial markets. Our team is working day and night to tailor trader development plans, build powerful and user-friendly CFD trading tools, and create guides to build profitable trading strategies.
Why AvaTrade is the best Forex broker for you?
- Trade with Confidence: Best Forex trading broker with over 14 years of experience and international regulations.
- A Large Selection of Assets: AvaTrade clients can trade CFDs with cryptocurrencies, indices, commodities, stocks, Forex currency pairs, ETFs, and bonds.
- Best Trading Conditions: Spreads as low as 0.9 pips, leverage as high as 400:1.
- Anywhere, Anytime: 24-hour trading with MetaTrader 4 and MetaTrader 5 trading platforms and our state-of-the-art AvaTradeGO mobile trading application.
- Master the Markets: Build your knowledge in our Education centre, stay informed with our Market Analysis, develop your skills in Demo Account, and manage your risk with AvaProtect.
- Feel Valued: Your personal account manager will guide you through your trading journey, and our award-winning multilingual support team will assist you at every step.
What are the advantages and disadvantages of CFD trading?
Advantages of CFD Trading
- Leverage: Leverage is a trading tool which reduces the margin requirement to trade a financial asset. For example, AvaTrade offers 10:1 leverage in Apple stocks CFD trading. If Apple stock price is $250.00 and you want to buy 100 shares; with a traditional broker, you would pay $25,000 to purchase the shares, with AvaTrade you would allocate only 10% margin which is $2,500. Leverage enables us to make larger profits with smaller capitals, but it must be noted that the losses are also magnified in the same proportions.
- Limited Risk: CFD trading can be done only with your available margin; so, you cannot lose more than your capital in the account – even when trading with leverage. No debts!
- Trading Flexibility: CFD markets are traded in two directions: long and short. You can open Buy or Sell contracts at your will, depending on the market direction.
- Control and Manage: You can apply your trading strategy and manage your risk with a wide range of orders, including Take Profit, Stop Loss, and Pending Orders.
- All Markets, Single Platform: The beauty of CFD trading is that you can take advantage of all opportunities with one-click access to any market around the world, any time you want, from one platform.
- Instant Execution: The electronic and online nature of CFDs allow AvaTrade to transmit your orders to execution venues instantly.
Disadvantages of CFD Trading
- Speed of Loss: The most common issue among traders is ignoring their own trading plan, applying large leverage, not using risk management tools, and finding themselves at the wrong side of the market which can translate to rapid losses.
- Spread: While traditional brokers’ high fees, commissions, and capital requirements are not present in CFD trading, every position starts with a small loss due to the spread between buy and sell prices.
- Rollover/Swap: Leaving a position open at night to carry it to the next day incurs a rollover commission which is earned or paid, depending on the interest rates of the underlying asset of the CFD.
Why is so important to have a trading strategy in CFD trading?
As in all kinds of investments, a solid trading strategy is essential to achieve long-term success in CFD trading. Good trading strategies include specific assets, influencing factors, position opening and closing parameters, and guides to adapt to markets.
Preparing the portfolio for both profit consolidation and risk management is the main factor that makes a trading champion. In AvaTrade, we are dedicated to developing our traders from zero to hero. Thus, we have a comprehensive Education section, including professional trading strategies, which you can visit to learn all aspects of CFD trading to construct the best CFD trading strategy.
Let’s start learning what CFD trading is and how to trade CFDs
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How much do you need to start trading CFDs with AvaTrade?
Like every investment, the earning potential increases with the invested capital. As you fund your real account with stronger margin, you will be able to take advantage of more opportunities at the same time. Plus, you will also be able to open larger positions, which, in turn, would increase the return potential. Furthermore, a large capital will also enhance your resilience against the adverse market conditions and protect your positions when the prices are fluctuating.
CFD traders often start with an initial capital between $1,000 and $5,000 when they register with AvaTrade. Although it is possible to open the account with a hundred dollars, the most successful traders often emphasise that only 1%-3% of the account balance should be used as margin across open positions. This is a fundamental risk management strategy when trading CFDs. With a starting capital of $1,000 to $5,000 will allow you to trade multiple positions in the beginning and get the actual feel of several markets.
The true amount to start trading CFDs depends on you and the assets you are interested in. You should never risk more than you can afford to lose. For example, currency pairs are generally low in value and high in leverage; so, their prices are lower, and margin requirements are low. On the other hand, commodities CFD trading is pricier due to the value of precious metals and energy resources. Although they have moderate leverage, their margin requirements are still significant.
How are CFDs divided?
AvaTrade offers CFDs of seven types of financial assets:
- Forex Currency Pairs CFDs: Majors, minors, and exotics
- Commodities CFDs: Precious metals, energy resources, and agriculture
- Stocks CFDs: U.S stocks, European stocks, and Asian stocks
- Index CFDs: U.S. indices, European indices, and Asian indices
- Cryptocurrency CFDs: Bitcoin, Ethereum, Ripple, and other altcoins
- ETFs CFDs: VIX, Gold Miners, Energy Select, and MSCI
- Bonds CFDS: Euro-Bund, Japan Government Bond
How to open a CFD position?
All CFD trading is conducted in AvaTrade’s trading platforms: MetaTrader 4, MetaTrader 5, Web Trader, or AvaTradeGO mobile trading application.
- MetaTrader 4 and MetaTrader 5: To open a CFD position, find your favourite asset on the Market Watch window located on the left, and double-click. In the Order window, set the position size in the Volume row. You can see the unit-volume correspondence (in lots) of an asset by right-clicking it in the market watch window and checking specifications. Then, set your Stop Loss and Take Profit levels, and then click either Sell or Buy button to open the position in the direction you predict.
- Web Trader: In the Trade tab, first search the symbol of the asset in the left column and choose it. In the right column, you will see the order window. First, choose the direction as Sell or Buy; then, write the amount in terms of units; choose your Take Profit and Stop Loss options. Finally, click the execution button at the bottom and open your position.
- AvaTradeGO: After you open the application on your mobile device, choose the asset you want to trade. In the Trade window, choose either Buy or Sell direction, enter the amount, set your Stop Loss and Take Profit orders and then click the circle button located on the bottom right corner.
How to use leverage when trading CFD?
Leverage magnifies the trading capital by decreasing the CFD margin requirement. This allows traders to open large positions with large pip values while using only a small amount of capital. For example, you notice an uptrend in Gold prices and want to take advantage of it by buying Gold and selling when it gains value. When you purchase Gold, every time its market price increases by $1, you will earn $1 for each ounce you have.
Let’s say Gold is currently trading at $1,500 per ounce and expected to close the day at $1,540. If you wanted to purchase 100 ounces Gold, you would have to invest $150,000 and earn only $4,000 at the end of the day. Instead, you can trade Gold CFDs with AvaTrade and take advantage of 200:1 leverage in two ways:
- Increasing position size: If you had a capital of $1,500 for Gold, you could purchase only one ounce of physical Gold with it, and at you would make only $40 profit. When you trade with AvaTrade, your Gold capital is multiplied by 200 and becomes $300,000. With this, you can buy 200 ounces and have a pip value of $200. When Gold closes the day at $1,540 and your profit would be (200 ounces x $40 change/ounce) = $8000.
- Decreasing margin requirement: If you want to buy 100 ounces, 200:1 leverage reduces your margin requirement to 0.50% of the actual value. You would invest only $750 to open this position, instead of paying $150,000 to purchase 100 ounces of physical Gold. Your pip value would be $100. The $40 change in Gold price would be $4,000 profit for you either way; however, with CFD trading, you would have to invest only $750 instead of $150,000.
How to calculate pips?
pip is the nominal reference digit of the price of an asset. In Forex currency pairs, the fourth decimal of the price is called pip, and the fifth decimal is called a pipette. For example, if EUR/USD is trading at 1.12567 – 6 would be pip and 7 would be a pipette. In other CFDs, pip usually refers to the first digit before the decimals. For example, if the S&P 500 index CFD is trading at $2398.10 – 8 would be a pip.
Pip value is an important reference point when calculating spreads, profits, and losses. It helps understanding the actual value of the cost of the position as well as how much profit or loss would be each time the market price of an asset moves. Pip value calculations are as follows:
- 4-decimal Forex pairs: (Position Size) / 10,000
- 2-decimal Forex pairs: (Position Size) / 100
- CFDs: $1 for each unit of the underlying asset
CFD Trading Tips
- Have a trading strategy: Prevailing in the financial markets require knowing your strengths and weaknesses. A well-built trading strategy would help you understand your trading style, guide you throughout your trading journey, and give you confidence when trading.
- Mind your trader psychology: Emotions can be very beneficial as well as very adversarial; however, the ability to regulate your emotions while trading can get you most consistent results. Practice emotional regulation when trading.
- Study, analyse and practice: Be picky about which assets to trade and study well to learn them in and out. Analyse the factors that influence their value and study past price movements. Practice your knowledge on a Demo Account to gain insights.
- Manage your risk: Always use Stop Loss and Take Profit orders to protect your position against sudden market changes, and build a risk management strategy with budgeting, leverage limits, and portfolio diversification.
Main CFD FAQ for Expert Traders
✅ How long can I hold a CFD?
CFDs do not have an actual expiry date and can remain open as long as possible. However, keeping the position open after the market close can incur fees known as a rollover in CFDs or swaps in Forex currency pairs. Therefore, it would be in your best interest to calculate possible swaps in advance and project it onto your expected return.
✅ Is CFD trading taxable?
CFD trading, in general, is a taxable income and subject to capital gains tax within EEA. However, UK residents can take advantage of Spread Betting, which is exempt from both stamp duty and taxation.
✅ Does CFD expire?
CFDs are not traded in a regular stock exchange, and therefore don’t have expiration dates that would require buying or selling the underlying asset at a certain price.
What is the difference between CFD and futures?
CFDs and futures contracts are similar derivatives, and they both offer leveraged trading; however, futures contracts are traded in the stock exchanges, and CFDs are traded between traders and brokers. Thus, CFDs has more flexible trading requirements, such as higher leverage, lower capital, and flexible contract sizes. Moreover, futures contracts have expiration dates and are exercised on expiry, while CFDs can remain open until the trader decides to exit it.
Is Forex a CFD?
The term Forex itself means foreign exchange; in other words, trading currencies against each other. In online Forex brokers, Forex trading is virtually conducted as a CFD, and the currency pairs serve as underlying assets in the contracts. Similar to stock, commodity, and index CFDs, where the underlying asset is traded against a currency and form a pair like XAU/USD (Gold), in Forex trading the base currency (e.g., EUR) serves as the underlying asset that is traded against another currency (e.g., USD) and form a pair like EUR/USD.
Let’s start learning what CFD trading is and how to trade CFDs
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