Basic Information

• What is CFD Trading?

  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.

• How does CFD trading work?

  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.

• What is the spread?

  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.

• What is holding cost?

  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’.

• What is margin and leverage?

  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

• Advantages of CFD trading

  - 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

• Understanding what can affect price movements

  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.

• Example of a CFD trade

  Going long – Outcome A: winning trade

  In this example let’s say the EUR/GBP is currently trading at 0.87545 / 0.87555, and you are expecting the price of EUR/GBP to go up and so you buy 50,000 (0.5 lots) worth of EUR (Euros).

  You were correct and one hour later the price has increased to 0.88105 / 0.88115. You then close the trade and sell the EUR at 0.88105.

  The market has moved 55 points (0.88105 - 0.87555) in your favour, meaning you would have made a £275 profit (50,000 x 0.88105) – (50,000 x 0.87555).

  Going long – Outcome B: losing trade

  Unfortunately, you predicted wrong. The price insteads dropped to 0.87112 / 0.87122 and you decide to close your trade.

  The trade was closed at 0.87112 (Sell price); therefore, in this instance the trade moved 44.3 points (0.87112 – 0.87555) against you incurring a total loss of £221.50.

  Going short – Outcome C: losing trade

  Let’s say the EUR/USD price is currently 1.12791 / 1.12799 and you believe the value of the EUR against the Dollar will fall and decide to sell EUR 70,000 worth (0.7 lots).

  The client’s prediction was correct and the price drops down to 1.11510 / 1.11518, so you close the trade.

  The market in this instance has moved an astonishing 127.3 points (1.12791 – 1.11518) and generates you a profit of $891.1 (70,000 x 1.11518) – (70,000 x 1.12791)

  Please note that the calculation of profit in CFDs is in the second currency (referred to as the ‘quoted currency’), which is why in the last example the profit was calculated in USD. If the account is denominated in another currency, it will be converted into the required base currency.

• Risks of CFD Trading

  When trading, please be aware that there are risks associated with CFD trading. You can lose more than your initial deposit. You are using leverage meaning you are trading with more than your initial margin. This can amplify profits but can conversely amplify losses. You should make yourself fully aware of all risks before being involved in trading as your capital can be at risk.