Basic Introduction to CFD Trading
CFDs (Contract For Difference) are a type of derivative instrument that allows you to easily take long or short positions in underlying assets such as commodities, stocks, indices, cryptocurrencies, and currencies. When you are trading CFDs online, you do not directly trade the underlying asset; instead, you own an instrument that follows/tracks the underlying asset’s price.
Long position = you profit if the price rises.
Short position = you profit if the price falls (blank)
Purchasing CFDs entails taking a long position.
Shorten your position by selling CFDs (blank)
Selling CFDs that you already own equals a zero position.
Purchase previously sold CFDs/blank = zero position
CFD brokers comparison
How does CFD trading work?
When you buy a CFD, you bet on whether the value of a stock, commodity, or currency will rise or fall.
The underlying asset is the stock, commodity, or currency.
When you press the buy button, you are betting that the underlying asset’s price will rise.
Instead of choosing to sell, you bet that the underlying asset will fall in value (you can say that you are short).
This is one of the many advantages of CFD trading.
You can easily invest in a downturn.
Click on sell and select the size of your position.
Leverage and safety requirements
Leverage is part of every CFD. It is based on what is known as a safety requirement. A security requirement is a requirement that you have a certain amount of cash in your account to take a particular position. Assume you want to invest in gold, as shown in the image above. It is necessary to have approximately GBP 700 in your account to take a position of approximately GBP 14,000 in gold.
This provides you with significant leverage.
You only bet £700, but your gold position is worth £14,000. The security requirement, in this case, is 5%. When the safety requirement is 5%, the lever will be 20 times (20x). As a result, you must have 5% of the size of your position in cash.
If your position falls in value, the loss will be deducted from your GBP 700. Because the leverage creates such a significant position, tiny movements are required for your GBP 700 to be doubled or reduced to GBP 0 in value. To protect yourself from this, make sure to keep your positions small and have significant margins on the safety requirements.
To be on the safe side, you may prefer this position to have around GBP 7,000 in cash/security in their account. Then you’ve reduced your leverage from 20X to 2X. If GBP 7,000 is too much for you to invest in, you could take a minor position instead.
If you take too many significant positions, your safety requirement will be quickly deleted, and your position will be automatically closed with a loss.
If you only have GBP in your account, for example, you should probably limit your positions to no more than GBP 1,400 or something similar to be on the safe side.
As an example, consider the
The share price of Volvo Ab is GBP 100. You predict that Volvo Ltd will rise and then purchase ten CFDs with Volvo Ltd as the underlying asset at the GBP 100 level. Your total position/exposure in Volvo Ltd is then GBP 1,000.
You have deposited a total of GBP 100 into your CFD trading account.
If the security requirement is 5% (%), GBP 50 will be deducted from your account as a security deposit.
If Volvo Ltd rises to GBP 105 and you decide to close your position and sell for GBP105, you will have earned GBP 5 x 10 = GBP 50 on your transaction, minus any brokerage. This means you have made a 50% profit on the money you put into your CFD account.
If, on the other hand, Volvo Ltd falls to GBP 90 and you decide to close your position and sell for GBP 90, you will have lost GBP10 per CFD and would have purchased 10 pcs. As a result, you have lost a total of GBP 100. The loss is equal to the amount you deposited in your CFD account, implying that you have lost 100% of your deposited money.
Examples of collateral requirements for various CFDs
5% to 10% index
3.3-5 per cent in currency
20 per cent in stocks
50% of cryptocurrency
Commodities 5% to 10%
Calculate leverage using the safety-requirement-calculator.
How much security is required for the position in kronor?
What is the value of one unit of underlying cost?
What number of contracts do you want to buy or sell?
In this position, the lever is:
Answers to questions
When trading CFDs, can you lose more than the amount invested?
Answer: Yes, in some cases. Do you have to pay taxes if you trade CFDs?
Answer: Yes, just like with ordinary shares, 30% of any profit is taxed.
Can I use a stop-loss order when trading CFDs?
Yes, you can set regular stop-losses as well as a guaranteed stop-loss on the platform.
It is ALWAYS triggered, even if the underlying asset has a gap.
As a result, a guaranteed stop-loss is far more secure.
A standard stop-loss risk that is not triggered by gaps in the underlying asset, for example.
Why should you use a CFD?
One might wonder why one would want to trade with an instrument that tracks the underlying asset’s value rather than the asset itself.
The most significant advantages of CFDs trading are the ease with which you can enter a position and the possibility of leverage that you can control.
CFDs trading allow you instant access to almost all assets, including indices, commodities, cryptocurrencies etc. and so on, in the simplest way possible. There is always the option to buy and sell.
It is also a very straightforward way to go short (blank) an underlying asset.
Taking a short position in CFDs is by far the simplest way to invest in an underlying asset decline.
One reason for trading CFDs is that it is one of the few financial instruments that allow you to trade with leverage.
This means that you can borrow in a way that allows you to make more money even if you have a little less cash.
The disadvantage is that the risk of losing money is higher.
But, of course, this opens up the possibility of making more money than you could with “ordinary” stock trading.
With leverage comes the benefit of tying up less capital in each position.
If you invest GBP 100,000 in ordinary shares, your money will be locked up in the shares.
If you use leverage, you can, for example, deposit security (the so-called security requirement) of 10%, i.e. GBP 10,000, and still trade for the remaining GBP 90,000 in other positions.
Of course, there is a risk involved here as well.
You have the option of determining the size of your security requirements and thus your leverage.
When trading ordinary shares, you make money primarily through price increases and dividends.
When you trade with an instrument like this, your ability to make money grows because you can make money during downturns.
You should think about if you understand how CFD trading works and if you can afford to lose the money you are trading with before you start. Options and turbo warrants are complex financial instruments and you risk your capital. Losses can occur extremely quickly.
CFD trading taxes
CFD trading is taxed in the same way as stock trading, i.e. with a 30% profit tax.
Similarly to ordinary shares, you have the option to set off gains against losses to avoid paying tax on the total amount earned.
Consider the following risks:
It would help if you always kept in mind when trading CFDs because you do not take on too many risks.
You can lose more money than you have in this trade, so you must carefully assess your risks.
Always keep a close eye on the tool you’re using to ensure that you don’t go beyond your capabilities.
As a general rule, keep at least 50% of the size of your position in cash in your account to reduce the possibility of being automatically stuffed out of your position.
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The Contract between the client and the provider declares that any change of the CFD value, based on the underlying asset’s market price, during the time of the contact.
CFDs enable you to trade both ‘long’ and ‘short’.
‘Going long’ intends to trade a CFD to expect that the underlying asset will increase in value.
‘Going short’ signifies trading the CFD, expecting the underlying asset will decrease in value.
Live4Trading provides you with the information you need to understand CFD trading basics.