CFDs

CFD trading has boomed since it was first introduced in Australia by IG markets in 2003. This article is for those people starting CFD trading. The growth of the product can be attributed to the attractiveness of the products’ easy to access leverage, ease of use and easy access to the price movements plenty of securities worldwide. The CFD Trading dream is to be able to live off your trading profits.

The definition of CFD trading is: CFD stands for Contracts For Difference. A CFD is an agreement to exchange the difference between the entry and exit price of the contract. Usually there is no expiry date, or no limit to the value of the exchange and no restriction is you are buying first or selling first. However, these conditions change for each CFD provider and look into your terms and conditions.

When you trade CFDs, traders have CFD margin requirements to maintain. The CFD margin is like a deposit, kind of like a deposit for a house mortgage. The margin requirement is used to protect the CFD provider if they need to exit the trader’s position. Initial margin requirements varies from stock to stock, usually starts at 3% for blue chip companies and then varies all the way to 80% for unknown rarely traded company stock. However for currencies (forex trading), the margin requirement is as low as 1% (or 1 to 100).

The variation margin and the concept of marked to market is more important than your CFD margin requirements. The variation margin is your daily profit or loss on a CFD trading position. At the end of each day (the time varies depending on the broker, some defines their end of day as GMT 00.00) any profit gain is credited to your trading account or any losses is deducted from your trading account. The term "Free equity" is used to define your absolutely free cash in your trading account after your margin requirements is taken into account.

When your free equity falls below zero in your account, a margin call will be enacted against you. You will be contacted by your CFD provider to advise you on depositing more money into your trading account or to reduce your positions. You can choose to add some funds to your account from your bank account or credit card. Alternatively you can exit some positions to free the equity required in your account.

You are liable for finance charges when you trade CFDs are you are fundamentally borrowing money. However, there is no interest charge on positions which you close on the same day you enter the trade. Interest will be charged or credited if you hold a position overnight. The finance charges are typically based on the Reserve Bank of Australia (RBA) rate plus or minus a margin of about 2 to 3 percent. So if you are holding a CFD for an Australian stock, you will pay interest when you hold a long position.

Direct Market Access CFDs offer identical prices and liquidity to the underlying sharemarket price for the stock. Direct Market Access CFD trading has each CFD order placed as an actual buy or sell order ticket on the Australian Stock Exchange (ASX) – an order which appears on the trade queue and follows typical stock trading rules.

Market Maker CFDs offer a mirror of prices to the underlying sharemarket price for the stock (with some CFD providers guaranteeing market prices) but there is no obligation for the broker to follow the exact bid and offer exchange in your CFD trade, therefore the CFD provider ultimately has control over the trade entry and exit for the client. By trading your CFD with the CFD provider, your contract is only between you and your provider and it is their choice whether or not they will hedge the exposure of your trade on the market.

Contracts of Difference (CFDs) appeared in the decade of 80s in United Kingdom. They are now popularly known as equity swaps or CFDs in today’s institutional market. They are basically an agreement between the investor and the dealer or broker who provides Contracts of Difference to reconcile the difference between the opening and the closing price of a CFD trade position of an investor. The overall agreement is done on cash basis. So let’s learn about CFDs!

Pros and Cons of CFD Trading