Wondering what is CFD trading, or tips how to trade CFDs in Australia ?… if so, we can explain!
A contract for difference (CFD) is essentially an agreement or contract between you and your CFD broker. The contract is to trade the change in price of a financial asset (such as shares, indices, currencies, commodities, etc) from the time you open the CFD contract to the time you close it.
The CFD definition from Investopedia sums this up as a…
“tradable instrument that mirrors the movements of the asset underlying it. It allows for profits or losses to be realised when the underlying asset moves in relation to the position taken, however the actual underlying asset is never owned”
Introduction To CFD Leverage
CFDs are derivatives because their value is derived from the value of another underlying asset (such as a share, commodity or market index). Leverage is an aspect of CFD trading that is critical to understand prior to opening any CFD online account. With any leveraged derivative, including CFDs, you only have to put in a fraction of the market value of the underlying asset when making a trade. However, CFD trades are entitled to the same gains or losses as if you had paid 100%.
Leverage means small market movements can have a big impact on the success of your trades. Gains and losses are magnified and the risks are therefore also greater. When trading with leverage it is therefore imperative to understand the risks involved and learn to handle it correctly!
Trade CFDs Online
CFDs provide an alternative, flexible way to trade the price movements of thousands of global markets including stocks, foreign exchange, indices, commodities, binary options and more, without owning the underlying financial instrument. Trading CFDs online therefore reduces the capital, and margin requirements, often needed to trade such markets.
With online CFD trading, you do not buy or sell the underlying asset (eg physical shares such as ASX CBA or BHP). Instead you buy or sell a number of units (eg 1 BHP share CFD unit may be equivalent to 1 physical BHP share) to take advantage of trading opportunities. Because you don’t need to buy the underlying asset, you can benefit from share price movements with a fraction of the capital. CFDs are a leveraged product, so you trade with a margin where you only deposit a fraction of the full cost of the asset.
Unlike other derivative products like options and warrants, CFDs do not have a time limit. You can keep an open position with a CFD for as long as you want to take maximum advantage of the market movements. In the CFD market you are not forced to close a position because of an expiry date.
- CFDs provide additional flexibility in a trading strategy. CFD traders have the ability to open short positions, in addition to trading long positions as with traditional stock investors. Hence, gains can potentially be made in both rising, and falling markets
- Efficient use of your capital – CFDs give you ‘leverage’ so you can trade without having to put down the full value of a position. This in turn leaves capital remaining for other investments rather than being tied up in the one transaction
- Can trade a contract for difference to hedge an existing physical portfolio
- No fixed time period
- No time decay factor
- Access a wide range of global markets from one online CFD trading account
- Contracts for Difference (CFDs) are a complex, highly leveraged financial product. They require a certain level of experience, so may not be suitable for everyone.
Remember leverage can be a double-edged sword as both gains and losses are magnified, therefore risk management is essential!
- Liquidity / Gapping Risk – Liquidity risk is a reality of trading on any market. Market prices can move very quickly and sometimes skip one or more price points. Gapping is a fundamental risk of trading CFDs. For example, the price of a CFD could fall from $3.71 to $3.60 without trading at any of the prices in between. If you had placed a stop-loss or trade to sell this CFD at $3.69, your order may only be executed at the next available sell price, $3.60 (or less) in this case, or alternatively not executed at all (depending on the order type). This ‘gapping’ is most prevalent in times of low liquidity and at the start of trading sessions. This is exacerbated on derivative financial instruments that have a long period closed between trading sessions, such as share CFDs.
- CFD trading carries a high level of risk to your capital and can result in losses that exceed your initial deposit.
Please ensure that you understand all the risks involved. It is imperative to assess, understand and implement a defined money & risk management plan into your overall trading plan.
Trading Strategy Using A Hedge In The CFD Market
At the core of trading financial markets is the analysis, whether fundamental and/or technical analysis, a trader performs. In particular a trading strategy will generally look for opportunities (higher probability) a market or financial instrument may move in a certain direction. Hedging using the CFD market is particularly useful strategy for periods of market uncertainty or downturns.
For example, your shareholding (physical shares purchased in the stock market) may have appreciated in value over the years. However, you’re concerned the stock market may be about to turn, lowering share prices & wiping out some of your gains. By taking the opposite position and short selling stock or index CFDs, traders can manage potential downside risk. This is achieved by ‘locking in’ existing profit or loss without needing to sell any shares and crystallising a potentially taxable capital gain.
If market prices fall as anticipated, the CFDs will gain, countering the loss in value of the shares. If however, the markets do not fall, then the value of the shareholdings will continue to increase and the CFDs will loose value. Assuming the CFD trader or investor took a short position of similar value to their shareholdings, there will be no net profit or loss. Essentially one trade offsets (hedges) the other. This strategy is a protection mechanism, rather than to profit from falling markets.
These CFD trading strategies help investors control how, and when, to realise the capital gain in a share position/s.
Best CFD Trading Platforms
A CFD trading platform is the system or software a CFD provider uses to allow you to make CFD trades.
When opening an account with a CFD provider, you are generally given online access to their web trading platform. Depending on the type of CFD account, you may also have access to more sophisticated platforms such as IRESS Trader & MetaTrader (MT4 or MT5) trading platforms.
Many CFD provider’s have demo accounts where you can ‘test drive’ their trading platform, and your CFD trading strategies, before opening a live CFD account. On all our CFD provider comparison & reviews we provide links to the brokers demo accounts. We highly recommend opening a demo account for each CFD broker you’re considering for a trading account.
CFD Regulation Australia
When considering online CFD trading in Australia, verify the broker is regulated in Australia. Confirm they have a current Australian Financial Services (AFS) licence number, also referred to as AFSL, issued by the Australian Securities and Investments Commission (ASIC).
All CFD providers are legally obliged to give you a disclosure document called a Product Disclosure Statement (PDS) before you open an account. If you are considering acquiring any financial product, including a contract for difference, you should obtain and read the relevant Product Disclosure Statement and any other offer document/s prior to making any financial decision.
If you are unsure of the risks, or have any doubt whether you have sufficient financial resources or experience to trade these leveraged products, you should take professional advice before trading CFDs.
ASIC has also developed 7 disclosure benchmarks for ‘over-the-counter’ (OTC) CFDs to help traders assess the risks. These include:
- Client qualification
- Opening collateral
- Counterparty risk – Hedging
- Counterparty risk – Financial resources
- Client money
- Suspended or halted underlying assets
- Margin calls
The PDS should explain the key features and risks of trading CFDs. In addition, since 31 March 2012 for OTC CFDs, include information about the above disclosure ‘benchmarks’, which can help you assess the risks of the providers CFD products. Check to ensure the CFD provider meets ASIC’s 7 disclosure benchmarks. If they do not meet a benchmark, confirm the explanation of why not!
Understanding Contract For Difference (CFD) – ASIC Australia Resources
ASIC’s Andrew Templer explains below the concepts of a ‘long position’; ‘short position’ (short selling); leverage meaning; initial margin; and margin calls:
Video courtesy of ASIC MoneySmart
Understanding Contracts For Difference (CFD) transcript
Thinking of trading contracts for difference (CFDs)? – ASIC CFD trading Australia guide
Choosing A Reputable CFD Provider Best Suited To Your Needs
The success of CFD online trading doesn’t just depend on picking the right CFDs to trade. Finding the best CFD trading platform and reputable, Australian regulated, CFD broker who actually meets your needs isn’t easy!
You are relying on the CFD provider to:
- accept and process your trades efficiently;
- make payments owed to you while your trades are still open (e.g. notional ‘dividend’ payments);
- credit the proceeds of profitable trades to you; and
- pay you money out of your CFD trading account in a timely manner when you request it.
There are an overwhelming number of online CFD brokers to choose from. Many of which will have different offerings, platforms, regulation, pricing and the list goes on.
This is where we (Online Brokers Australia) really shine!
We only list the very best, hand-picked and reputable online brokers in each category. If they don’t meet our initial stringent requirements test, or don’t have a key point of difference CFD traders are looking for… we simply won’t list them!
Click here to compare our top 3 CFD providers. If you’re still wondering how to decide which CFD broker features you really need, please view our how to choose a broker page for excellent tips. There are eight critical factors to consider when choosing your CFD, Forex or online share trading broker.
Contracts for Difference (CFDs) are a complex, leveraged financial products. They require a certain level of trading experience, so may not be suitable for everyone. CFD trading carries a high level of risk to your capital. Losses can exceed your initial deposit. Please ensure that you understand all the risks involved.
If you’re considering acquiring any financial product you should obtain and read the relevant Product Disclosure Statement prior to making any financial decision. If you are unsure of the risks, or have any doubt whether you have sufficient financial resources or experience to trade CFDs, you should seek professional advice before trading CFDs online.