A CFD (Contract for Difference) is a derivative product which forms an agreement between two parties to exchange the difference between the opening price and the closing price of a contract at settlement. Trading CFDs gives you the ability to speculate on the prices of currencies, Indices and commodities in the market.
You never actually own the underlying asset and are instead trying to predict whether your chosen market’s price will either rise or fall. Irrespective of whether the market moves up or down, if you predicted the outcome correctly, you will acquire a profit and if you are incorrect, you will incur a loss.
With CFD trading, you don’t buy or sell the underlying asset. You are buying or selling a number of units or lots for a particular instrument depending on whether you think prices will rise or fall.
A ‘lot’ is a standardised amount of the asset that is traded. The size of the 'lot' changes dependent on the asset type: for example, 1 lot in forex is equal to 100,000 units of currency. Depending on your lot size, a pip movement will have a different monetary value
For every point the price of the position moves in your favour, you gain multiples of the number of CFD units you have either brought or sold. For every point the price moves against you, you make a loss and for every point the price moves in your favour you make a profit.
If you decide to go long (buy) you have an inclination that the market price will rise alternatively, if you go short (sell) then you believe the market price will fall. This flexible way of trading allows traders to benefit from any price movement regardless of direction.
The spread is the difference between the buy (Ask) and the sell (Bid) price. The buy is the higher price shown and the sell is the lower price.
When entering a trade, and for example you want to go long, you will Buy using the Ask price quoted, and to exit the trade you will Sell at the Bid price quoted. Tight spreads are important because the narrower the spread, the less the price needs to move in your favour before you start making a profit, or if the price moves against you, a loss.
Due to the interest rate obligations on the relevant instruments, any positions still open at the end of the trading day may be subject to a charge called a ‘holding cost’ (or swap fee).
The cost will either be positive or negative depending on the direction of your position and the applicable holding rate.
Holding cost information is available via the MetaTrader 4 platform by right clicking on an instrument in the market watch section, and selecting the ‘Specification’.
CFDs are a leveraged product, which means traders are only required to deposit a small percentage of the total cost that would be needed if they were to purchase the equivalent product in the physical market. This is called trading on margin and allows you to magnify your returns; but beware as you can also magnify your losses. This is because the trade is based on the full value of the position, which also means you can lose more than your initially deposited amount
- You never own the underlying asset
- You can trade on worldwide instruments including Indices, Forex and Commodities
- Access 24-hour markets
- You must pay capital gains tax but can use losses to offset tax liabilities
- Leveraged product meaning you can open a large bet with a much smaller deposit
- No expiry dates on trades, except on futures, binaries and options
Daily major economic news and events can have a significant impact on the market. This data typically gives an insight into a country’s economic or political health. It indicates what is going on in a particular country and usually dictates price movement. These figures are seen as statistical evidence to back up speculation on whether or not an economy is doing well.
There are many statistics which affect markets in different ways. For example, interest rates, Gross Domestic Product (GDP), retail sales, industrial production, inflation, public debt, economic and political stability all play a part in influencing market movements. Therefore, traders are often kept up to date with daily news in order to anticipate the effect an announcement will cause on the market. It allows investors to outline where it is most suitable to invest, if a country is going through a lot of political turmoil for example, investors will deviate from investing in such a country as their capital will be at greater risk.