The Complete Guide To CFD Trading

In this post we comprehensively answer the question “What is CFD Trading”. I’m going to helicopter you from blissful ignorance up to CFD Trading base camp where you can make an informed decision if climbing the mountain is your long term goal. What are the risks, what does success look like and what are the steps that you would need to take to get you there.

Make no mistake, the “climbing Everest” analogy is pretty accurate. CFD Trading is not a get rich quick path to easy money.

This is what is most likely going to happen to that first chunk of change you decide to start trading with.

And if you are like most people probably a few thousand after that too! Even after becoming profitable it’s not unusual to hear of successful traders having “blown up” a couple of accounts before finally mastering it.

Success in CFD trading is there for the taking, but it’s only available to those with an abundance of courage, grit & patience. If you are truely determined to succeed then you need to be committed for the long haul.

With education, discipline and continuous improvement you might just be one of the very small minority that is able to break even! If you can break even then from there the sky is the limit. Most people give up long before then.

This is a pretty long post so please use these quick links to skip or link directly to the relevant sections:

 


What is CFD Trading

Formally… “A CFD or Contract for Difference is an agreement between two parties to exchange the difference between the opening price and the closing price of a contract. “.

More simply “a CFD is an agreement between two parties – the investor and the CFD provider – to pay each other the change in the price of an underlying asset”

Placing a trade with a CFD is like buying a house. If you had enough money you could purchase the house outright with cash. Most people don’t though, they pay a deposit and the bank loans them the difference.

Since you are only required to put down a small deposit for a large position size you can make large profits – or losses – on the money you commit, from small moves in the price.

Take this comparison with buying a house:

Buying a $300,000 House with 10% deposit

You pay the bank your 10% deposit ($30K). The bank loans you the rest of the money you need to buy the house($270K).


If the price of the house goes up in value then that is positive equity which only becomes profit if you decide to sell the house.

If the price of the house goes down in value then that is negative equity which you must pay if you decide to sell the house.


The bank makes money from the fees and charges setting up your loan, the also earn money from interest on your loan.

Purchasing(going long) $300,000 worth of Shares with a 10% margin

You pay the broker your 10% margin ($30K, like a deposit but in trading this is known as your “margin”). The broker lends you the rest of the money you need to buy the shares($270K).


If the price of the security goes up in value then that is positive equity which become profit when you decide to sell it.

If the price of the security goes goes down in value then that  is negative equity which you must pay if you decide to sell the house.


The broker makes money from the fees and charges opening & closing your trade, they also earn money from interest on the money they loaned you.

Pretty straight forward eh, so with a margin(your deposit) of $2570.15 and leverage of 500:1 your exposure is $1 Million! WOW

CFD Trading gives you access to a huge variety of global markets including stocks, indexes, foreign exchange, treasury & commodity markets. Providing you with an opportunity to make money from each market moving up(long) or down(short) with very minimal capital requirements.

 

 


Why Use CFD’s?

Advantages


  • Go long or short
  • Hedge your portfolio
  • 24Hr dealing
  • Leverage amplifies profits
  • Access to a wide range of markets
  • Guaranteed stops
  • Transactions are settled immediately (normal stock brokerages take 2-3 days)
  • Tax advantages

Disadvantages


  • Don’t own the underlying asset
  • Not legal in all countries (including the US)
  • Leverage amplifies losses
  • Losses can exceed your deposits
  • Interest payments can rack up if you are holding for a long time

 

 

 


Is CFD Trading For Me?

Stay Away If …


  • You are a gambler, impulsive or not responsible with your money
  • You are indecisive
  • You are a novice or beginner share trader
  • You become emotionally attached to positions
  • You lack discipline
  • You are impatient
  • You aren’t prepared to create a trading plan
  • You aren’t prepared to keep a trading journal or do honest self reflection
  • You aren’t interested or able to commit the time to learn

 

 

 

You’re a Good Match If …


  • You have an ability to tolerate a reasonable level of risk
  • You are patient
  • You are decisive
  • You have good self control
  • You have good emotional intelligence and self awareness
  • You are confident in your own abilities
  • You can create your own plan with defined rules based on your own goals & strategy
  • You follow your trading plan
  • You use a trading journal to track your trades and reflect honestly about where improvements can be made
  • You have a growth mindset and take the time to learn about the market, the product, the risks and what it takes to become successful
  • You are an intermediate or experienced share trader who is familiar with share markets
  • You are a full time trader
  • You have capital that can be lost

 

 


Where Did CFD’s Come From?

It’s hard to believe but CFD’s as we know them today only originated in the 1990’s by a London derivative brokerage firm called Smith New Court. As with most inventions it was born out of a need. Hedge funds needed a simpler way to short sell in the London Stock Exchange. The main benefits were the ability to trade with leverage and avoid stamp duty on any profits, neither were options were available with standard share dealing.

With the technology boom shortly after they became available to individuals through online trading platforms.

 

 


Going Long or Short

Going long is when you buy a security and you make money if it goes up in value. Most people get this.

One of the benefits of trading with CFD’s over normal securities however is that they give you the ability to short a security. When you short a security you make money if it goes down in value.

Being able to short a security is extremely useful because often markets are moving downwards and we may be able to anticipate that and can therefore benefit from it.

While you may have heard the term (“for example it was explained well in the Hollywood movie, the Big Short”) shorting just isn’t something familiar to most of us. Most things we buy and hope that they go up in value and then expect to lose money if they go down.


To explain the concept we’re going to bring it back to something everyone is familiar with …. lawnmowers.

So lets say you have this lawnmower fetish (I won’t judge.. promise) and buy the latest, greatest Super Deluxe Lawn Mower for $1000.

I think you’re crazy because I know that in a few weeks you will be able to buy these exact same lawnmower’s for half what they’re worth now.

I ask to borrow it and because you are such a tip top super friend you agree.

I’m more shades of grey(I don’t mind being judged) and immediately proceed to sell your pride and joy for $1000. Ouch!

I now have $1000 and neither of us have the lawnmower. You’re not phased as you know that I while I’m a bit a of a beardo for selling it I will definitely eventually give you your lawn mower back.

4 weeks later the price of that lawnmower has dropped to $500 so I buy one and return it to you.

I now have $500 and you have your lawnmower back. Sweet!


To make short selling happen there is actually a quite complex arrangement going on in the behind the scenes. People who own securities make an agreement that their securities can be loaned out with the expectation they will be returned. When you place a short trade you first borrow a security from the broker, then immediately sell the security. Later when you close your position you buy the same security back and return it to the broker.

It does come with some side effects though…..

Let’s say that shortly after selling off your lawnmower a breed of super grass mutates and starts taking over gardens. Panic sets it when people realise that it grows to 5m tall and needs mowing 3 times a day and you guessed it, the only lawn mower that is up to the task is the Super Deluxe Lawn Mower.

BOOOM overnight the price of the Super Deluxe Lawn Mowers skyrockets to $50K each.

I’m doing my best to avoid your calls and cross the street and avert my eyes when you see me but eventually I realise they are only going up in value so I make a plan to give you yours back! GULP. I go out and buy one for $50K and give it to you.

I’m now down $49K and you have your lawnmower back. Gulp!

Unlimited Downside Risk
This story might sound a little ridiculous but it highlights a very real risk of shorting. The value of a security can only go down to zero so when you go long the maximum amount you can lose is if the value goes to 0. There is no limit to how high a security can go up in value so when you short there is no maximum amount you can lose.

It doesn’t happen alot, but it is possible? Take Joe Cambell who went to bed with $37K in his trading account after shorting a stock and woke up with a debt of $106,445.

We will cover the risks in more detail later in this section.

 

 


Margin and Exposure

Margin trading gives you full exposure to a market using on a fraction of the capital that you would normally need.

Margin is the amount of money you need to open a position, defined by the margin rate.

For example if you were going to purchase $1000 of shares through a traditional broker you would be required to pay the full $1000 up front to own them(plus brokerage charges).

As CFD’s are leveraged products you don’t need to pay the full value of your exposure in order to deal. Instead you put up a fraction of your total exposure to open your position.

If your CFD broker provided the same shares with a leverage of 1:10 then you would only be required to put down $100 and you would have the same $1000 exposure in the market.

There are two types of margin to consider:

Initial Margin

The initial margin is the percentage of the purchase price of securities that you must pay for with your own cash.

The initial margin required can vary substantially between brokers & markets. A broker may also adjust this depending on the volatility of the market.

For example, in the lead up to Brexit most brokers increased the margin requirements substantially. As it was a predictable event with significant volatility and liquidity risks they took these measures to reduce their own and their customer’s risk. A few days after the event they returned the margin requirements to the original values.

Maintenance Margin

The maintenance margin is the percentage of funds required to keep your position open.

If a position moves against you your equity declines. If it goes below a level that would have allowed you to open the position in the first place then the broker can request that you deposit money to cover the running losses.

This is known as a margin call.

Back in the day before electronic trading your broker would need to call you to tell you the bad news that you need to either stump up some more cash or your positions would be closed out. Today with electronic trading this is generally done systematically.

You may receive an alert or notification that you need to do something but if you are unable to deposit money and the position continues to move against you then the broker could take action by closing one or all of your open positions automatically. It is also possible that they do nothing and your account reaches the point where your trading capital is gone and you actually owe them money (this is the scenario you are warned on where losses can exceed deposits).

With multiple positions open you can find yourself in the situation where one of the trades triggers a margin call and your broker automatically closes both your losing and your profitable positions(that you would prefer to keep open) to keep your account from going further into negative equity.

Usually none of these scenarios is ideal so it is important that you manage your money and your risk(with stop losses) to avoid getting into these situations.

 

 


CFD Trading Costs

When trading you incur costs opening positions, closing positions. You also receive charges on the funding and interest for the margin.

Spread or Commission

When opening or closing positions a broker will charge you either by adding to the spread or by a commission. Shares are usually charged with a commission and everything else is usually with a spread.

With shares for example you may pay $5 to open a position and $5 to close it, regardless of the profit or loss you make on the trade.

With non shares the sell price might be 100 and the buy price 105. The broker would have added 2 to the difference as their charge.

Holding Costs: Overnight Funding / Interest

CFD positions held overnight are subject to overnight financing. Interest is calculated and charged daily on the contract value. When shorting shares you are actually triggering a sale of the security so interest is earned(usually at a lesser rate than when going long).

This interest adjustment may be based on the 1-month interbank funding rate (eg. LIBOR) or for forex positions it may be based on the current tom-next rate.

 

 


CFD Trading Risks

In trading, risk is the potential that your chosen investment may fail to deliver the outcome you anticipate. This could result in lower returns than expected, but it could also mean losing all or part of your original investment, or in certain cases even more than this.

Leverage Risk: Magnified Returns And Losses

The volatility of the stock market and the leverage on your investment is a combination that can result in rapid changes in your investment position. When you purchase shares using the traditional “buy and hold” strategy your position could move 20-30% down and you would have the option to wait for it to come back again.

With CFD’s this movement could wipe out your account, it could leave you in a position where you actually owe the broker money. All of this can happen in such a short time while you are sleeping or away from your computer. Some brokers offer leverage up to 2000:1 which can seem tempting when you consider the upside and it is often used by people who have the least capital.

Mitigation Strategy:
Create a trading plan that balances the amount of leverage, position size and risk / reward ratio.

Counterparty Risk: Your CFD Broker

While you are trading your money is transferred to your CFD Broker. Brokers can manage your money in many different ways and the approach they take affects what could happen if they go out of business. If a CFD provider uses your deposited money as an unsecured loan to meet their liabilities or margin requirements and the go under you won’t be able to withdraw money and may receive a fraction if anything at all of your money. This

CFD brokers aren’t banks so they aren’t scrutinised by regulators. It differs from country to country but the CFD industry is for the most part self regulated.

Example

Mitigation Strategy

  • Choose a Broker Carefully
    Read your broker’s risk management plans and how they deal with counterparty risks. Choose a broker who segregates your money and doesn’t use it for hedging or any other operational purposes.

Short Selling Risk: Unlimited Downside

Shorting is explained in more detail in this section. The risk with shorting that you don’t have when you go long is that the value of a security can only go down to zero so when you go long the maximum amount you can lose is if the value goes to 0. There is no limit to how high a security can go up in value so when you go short there is no maximum amount you can lose. Of course no security goes up indefinitely but it could reach the point where you.

Example
Joe Cambell went to bed with $37K in his trading account after shorting a stock and woke up with a debt of $106,445.

Mitigation Strategy

  • Guaranteed Stops
    Guaranteed stops will close at the price requested regardless of what happens. The broker is responsible for paying the difference, not you.
    Don’t Hold Overnight , Over Weekends or During Major Events

Volatility Risk: Slippage, Liquidity & Gapping

An asset is considered liquid when it can easily be bought or sold quickly at a price where the gap between buyers and sellers is minimal. If there are a lot of active traders, this will create good liquidity as there are likely to be a mix of buys and sellers who are willing to trade. The more liquid a market is, the easier it is to buy or sell that asset at a efficient price.

Examples

All stocks, indexes, foreign exchange, treasury & commodity markets can experience lack of liquidity and gapping at times. Some are more generally more illiquid than others. Penny stocks & properties for example can be quite illiquid. An example of a currency is when the Swiss scrapped their currency ceiling. This guy shorted a company and when it opened the next day it had gone up 800%.

Mitigation Strategies

  • Asset Choice
    Asset liquidity is usually associated to the types of assets. Committing a large proportion of your capital to illiquid markets should be avoided and an exit strategy planned in advance which considers the scenario where you are unable to liquidate your position at the price you desire. Most markets close and when they are closed they can gap significantly with major events.
  • Trading Times
    Even normally liquid markets have times when they are illiquid. These are usually when most of the traders are either asleep,  when markets are first opening or before big news events. It’s best to know these in advance and avoid them. As you become familiar with a market you can observe when conditions are illiquid.
  • Order Types
    Guaranteed stops provide protection against gapping & liquidity risks. A normal stop loss will help you to manage your risk & money in normal conditions. Unfortunately they don’t offer any guarantee to being able to close the position at the price you have specified. A guaranteed stop will close at the price specified regardless of what

Money Management Risk: Capital Loss

Good money management is a foundational element of successful CFD trading.

Trading volatile markets with leverage can easily wipeout your entire capital, no matter how much money you start with. You may have a lucky trade but to be consistently profitable you need to develop your own strategy and then have the discipline to follow it. Money management requires a variety of mitigation strategies that all need to be applied consistently for it to work. Having a plan but not following it is as damaging to your account as having no plan at all.

Mitigation Strategies

  • Realistic Expectations
    Leverage is a powerful tool but it’s important to recognise that even when you do it successfully you won’t become a millionaire overnight. You account should grow at a consistent rate and not jump wildly up and down(ie. big wins & big losses). Your focus should be on judging yourself on how well you stick to your plan and staying in the game not how much money you make.
  • While Learning, Risk the Minimum Amount Possible
    It is likely that you will take atleast 12 months before you start to become more consistent. Your goal during the learning period should be to lose as little as possible. Focus on learning, improving and judge yourself on how well you follow your trading plan.Think about it. If you are profitable you will be trading with the profits you make and then using that to make more profit. Sinking more of your own capital isn’t the solution. Developing a good trading plan and applying it with self control & discipline is. Once you become consistent then you could choose to put more of your own capital or just trade with the profits.
  • Develop a Trading Plan
    A trading plan is the corner stone of successful trading. Then plan outlines the rules that you need to follow. Details such as what markets to trade, the leverage, the position size, the stop loss type & risk amount & the conditions that are required before you position on and when to take profits.
  • Self Reflect with a Trading Journal
    Your trading plan should provide you with the guidelines for when and how you should trade. When you start trading you find that for many reasons(most of them emotional) following your plan is quite challenging. Reflecting on the trades you make while they are still fresh and finding learnings from them is crucial. Either you need to improve your discipline and follow your plan or your plan needs to be updated with new rules. Knowing which mistakes are costing you the most and which you are repeating and prioritising addressing them should be your number one priority.

Psychology Risk

Good self awareness, patience, discipline and continuous self improvement are fundamental to successful CFD trading.

How you feel & respond to your trading – is a crucial part of the trading process. Emotions such as fear, greed, stress, joy & anger all influence our trading decisions. If you are fearful then you may hesitate even when an opportunity that is part of your plan presents itself. Greed comes into play as your trades are successful and you want more. Taking more risk or not closing profitable trades in profit in the hope of making more. Stress in other aspects of your life can cloud your judgment. Being joyful in your life can also make you feel more optimistic and take risks that would normally not be in your comfort zone. Finally anger, where you regret your decisions or an outcome and take revenge trades that are outside your normal trading plan.

Impatience and boredom can lead to over-trading. Taking trades that aren’t part of your trading plan lowers your win rate.

Mitigation Strategies

  • Patience
    Being able to wait is fundamental to successful CFD trading. It takes time to learn what conditions you are looking for to make a trade and even longer to develop the patience to wait for them. Every trade you take that isn’t part of your plan is reducing your chance of success.   
  • Staying Calm
    Being able to stay calm helps you make decisions for the right reasons. This can be done by creating a trading plan that helps to guide when to make decisions and also trading position sizes which are small. If everything is riding on this one trade then you aren’t going to be getting much sleep! Know that you don’t need to be right every time to be a successful trader.
  • Being Decisive
    On the other side of the coin it’s important to act without hesitation when an opportunity presents itself. Highly leveraged trading means that timing is extremely important.
  • A Trading Plan & Journal
    Are you tempted to increase your position size or making trades based on emotion? Your trading plan should describe when and how much to risk so you can easily see when you are off side! Your trading plan should also provide guidance for what conditions are required to make a trade. If all of those conditions are met then you can confidently make a trade. If you have a positive expectancy and then you know that some trades you win and some you lose but overall you make money. Self reflecting with a journal helps to identify where you are not sticking to your plan and what opportunities there are for improvement.

How to Trade CFDs Successfully

Trader Survival Rate
Trader Survival Rate

It is no secret that most retail traders fail. They don’t have experienced mentors to help them so they focus their precious time, energy and capital on the wrong things.

Tradeciety.com did a great post on the statistics that show why most traders aren’t successful.

Products & services available to retail traders have slick marketing material and provide lots of promises but lack substance. It’s not obvious when you start trading that things like money management & psychology play such an important role and they also are difficult to create products and service for. Therefore most products & services tend to focus on what traders think is most important.

 

 

 

Analysis & Trading Systems

CFDTrading: What Most People Think Is ImportantMost people think that successful CFD trading is about having the perfect system that is never wrong. It tells you the perfect entries & exits and never loses.

Unfortunately for them analysis & a trading system is only 10% of what makes you a successful trader. So they continue to focus on trying to understand and improve a part of their trading that has very little impact.

Trading analysis is about focusing on different information relating to a market and formulating a theory for what you expect to happen. It it used as an input to your trading plan.

For example doing fundamental analysis you might know that the China’s economy is slowing and their demand for raw materials is falling rapidly. Many commodities & stocks are dependent for their income on them will therefore fall in value. That gives you what the dominant trend you are looking to take entries on.

When you look at the price chart for one of these commodities you can use technical analysis and indicators to identify patterns of behaviour in the market.

The 3 main types of analysis are covered in more detail in the section below.

A trading system is a group of specific rules or parameters, that determine entry and exist points for a security. These points, also know as signals prompt the execution of a trade.

Having a trading system is important as it allows you to have consistency for when you are taking trades. If you are able to follow your system consistently then your win rate should be consistent.

Trading systems is where most products & services tend to focus. However, there are many free trading systems available that are actually quite easy to follow and use and also have pretty good win rates.

Pick one that suits you and stick to it but then move on to the stuff that is actually important.

References

Trading Psychology

CFD Trading: What is Actually Important

“Knowing yourself means understanding how you?re likely to behave under various circumstances. Over the past couple of decades, behavioural finance researchers have developed a clearer understanding of the psychological traps investors fall in. The best way for you to avoid these traps is to become aware of them, the forms they take, and which you are most likely to fall into.” – Michael J. Mauboussin

Once you have a plan then you need to stick to it. That is where the psychology comes in. There is alot of emotional pressure with trading which causes you to take action when you plan says not to.

The psychology of trading is so important because all trading decision making is clouded with emotion and making poor decisions erodes your capital.

Even successful traders can have a string of losing trades so if you combine a string of losing trades from good decisions with a string of losing trades from poor decisions you can reach a point where it’s difficult to recover. Causing you to make even worse decisions!

Here are five common pitfalls:

  • Over-confidence. Researchers have found that people consistently overrate their abilities, knowledge, and skill; especially in areas outside of their expertise. Investors must seek and weigh quality feedback and stay within their circle of competence.
  • Anchoring and adjusting. In considering a decision, we often give disproportionate weight to the first information we receive, hence anchoring our subsequent thoughts. You can mitigate this risk by seeking information from a variety of sources and viewing various perspectives.
  • Improper framing. The decisions of investors are affected by how a problem, or set of circumstances, is presented. Even the same problem framed in different, and objectively equal, ways can cause people to make different choices. Framing, too, plays a central role in assessing probabilities.
  • Irrational escalation of a commitment. Investors tend to make choices that justify past decisions, even when circumstances change. To avoid this trap, investors must only consider future costs and benefits.
  • Confirmation trap. Investors tend to seek out information that supports their existing point of view while avoiding information that contradicts their opinion. Psychologist Thane Pittman’s slip of tongue sums it up: “I’ll see it when I believe it.”

You must also understand how you tend to react under stress or boredom or impatience. People with different personality profiles behave in dissimilar ways when stressed. Here again, self-awareness and some basic techniques to offset suboptimal behaviour go a long way. Pearson declares, “A gambler’s ace is his ability to think clearly under stress. That’s very important, because, you see, fear is the basis of all mankind….That’s life. Everything’s mental in life.”

When you trade with a demo account you don’t have the emotion so demo trading can only provide limited real life trading experience.

References

Risk & Money Management

The relationship between your account size, risk percentage, win rate, position size, leverage and risk reward ratio is the secret sauce of successful trading.
 
It might sound unnecessarily complicated and you would rather just focus on winning more but understanding why balancing these elements is the first ingredient to profitable trading. 
Successful trading is about probabilities and risk management. You will never know 100% what the market will do so balancing these elements is how you manage the risk and allow the probabilities to work in your favor without blowing up your account first. 
However….. knowing the rules and following them are two very different things. That is where the psychology plays a part.
If you are like me and know what you should be doing and end up doing the wrong thing anyway then atleast you know what you should be doing. Hopefully over time you can see that it is more profitable to just stick to the plan!
First I’ll explain what each element is and then how they relate to each other
Your account size is easy to understand. How much capital do you have to risk.
The risk percentage is how much of your account you intend to risk with each trade. Risking 1-2% of your capital per trade is considered the maximum.
Your win rate is the number of trades that are successful. If you take 3 trades and you win 1 and lose 2 then your win rate is 33%. This can be calculated at any time from your historical trades.
The risk reward ratio is used when creating a trading idea to determine how much you expect to make in relationship to how much you could lose. First you determine when the stop should be placed to invalidate the trading idea, then you determine how far you expect the price to move. If you are risking 5 points and you expect to make around 20 points the the risk reward is 1:4.
There are two types of leverage you need to be aware of. The first is broker leverage and the second is the effective leverage. Broker leverage relates to your initial margin. The higher the broker leverage the less money is needed to open a position. Effective leverage is the amount oyourisk in relation to your account size. Even if your broker gives you 200 times your margin amount you can reduce your position size and therefore lower your risk amount.
The position size is how much you buy or sell.
So how do each of these factors interact ….

Risk Reward Ratio & Stop Loss

When creating a trading idea you need to identify at what point the idea is wrong(this is where you stop would be) and what your profit goal is.
The risk reward ratio is relevant regardless of how big your account is or how much your risk with each trade. The risk reward for a trading idea is used with your winrate to determine if this trade is one that you should take or not.
The stop loss is used when calculating the position size required for the trade.

Winrate & Leverage

Research by DailyFX shows that increasing leverage negatively impacts your win rate. The percentage of winning trades with 5:1 effective leverage is 61% whereas the percentage of profitable traders with 25:1 effective leverage is 17%.
The higher the effective leverage the lower your winrate.

Winrate & Risk Reward Ratio

Trading is simple –  Make more money with your winning trades than you lose with your losing trades. It isn’t about having a winrate of 100%.
Very successful traders can have a winrate of 40% or less and can still be successful. They do it by taking trades that have a high enough risk reward for their winrate.
Know what your winrate is. Depending on what your winrate is(remember the higher the leverage/position size the lower your winrate) you need to make sure that you only take trades that have a risk reward ratio that will ensure that you are profitable. 
Trend or swing trading strategies generally have quite high risk rewards so if you stick to those you should be on the right track.

Account Risk Percentage & Winrate

Having a risk percentage of too much per trade is one of the key reasons that many traders fail.
Consistently risking the same very low percentage of your account is necessary to protect yourself from losing too much money when you have a losing streak.
As a new trader you are likely to have more than your fair share of losing streaks and if you deplete all their capital then you can’t keep trading.
If you are thinking of risking more then consider that even the most successful traders can have losing streaks of 5, 10 or even 15 trades. Risking 5% of your capital per trade when experiencing a losing streak could end your trading career.
 
Trading more than 1% increases you chance of losing all or alot of your capital. Even if you aren’t wiped out it takes massive gains to simply get back to where you started. 

Leverage, Position Size & Winrate

Sticking to the rule of only risking 1% and moving your stop closer so that you can increase the position size or leverage is also another great way to shoot yourself in the foot.
All markets have a normal level of volatility so if your stop loss is too close it is more likely to get hit even if your trading idea is valid.
The closer you move your stop the lower your winrate will be.
 

Piecing It All Together

  • Account Risk Percentage
    You can’t predict the outcome 100% so only risking a small enough amount ensures that if you have a losing streak that you can live to trade another day.
  • Risk Reward Ratio
    When you plan a trade you determine where you need to place your stop and also what the profit target would be.
  • Winrate
    Knowing what the risk reward ratio is and what your winrate is gives you a go/no go decision.
  • Position Size
    A position size calculator factors all of these considerations in and spits out a position size that you can use when making your trade. The position size is provides ensure you only risk the x% while also having enough of a stop distance.

References


CFD Trading Analysis Types

With 1000’s of markets and the ability to go long or short and risk any amount of money at any time of the day you need to have a good reason to take a trade, otherwise you tend to lose money and not learn anything.

Finding a reason is achieved using different types of analysis. The different types of analysis aren’t mutually exclusive, skilled traders will often use many types of analysis when considering a trade. When multiples types of analysis are all in agreement then that is when you are more likely to be taking a trade for the right reasons.

Fundamental Analysis

Fundamental analysis is about studying everything from the overall economy and industry conditions to the financial condition and management of companies.

Fundamental analysis is about using information about using concrete information about a business or security to understand what the underlying value of should be.

Technical Analysis

The focus of technical analysis is to focus on the statistics generated by market activity and the price patterns that form on charts as the primary source of information. Price charts often form familiar patterns as market participants behave in predictable ways. The basis of this analysis is to look for patterns formed or forming. The patterns allow you to identify high-probability setups in reaction to the market.

It’s important to recognise that technical analysis isn’t some magical way of predicting what the price will be in the future. However, if there is a pattern then you can use that to anticipate what the price and pattern will do next. What is important is that you wait for confirmation that what you expect happens and then take a position when your prediction is confirmed.

There an many types of technical analysis but there are a few that everyone should know. They are:

Sentiment Analysis

It’s nice to think that if you understand the logic behind prices & markets then it will do what makes sense. What you quickly learn however is that people behave irrationally and with emotion and they are the ones driving the prices. Understanding the sentiment of the market is about analysing what the main players, understanding what they are expecting to happen and using that as an input to your analysis.

There is also data such as the commitment of traders report which show how many of the biggest players in the market are positioned. To complicate things further you often find that when the market has positioned itself extremely then there is a high likelihood of it going the opposite direction! An example of that is when everyone is expecting a market to go down so a large number of people short sell the market heavily. On it’s way down if it suddenly changes direction then all of the traders who are short need to start closing their positions(ie. buying back the stock) this is known as a short squeeze and is often a violent movement against the expected direction of the market!

 

 


CFD Trading Time Frames

Seconds to Minutes: Scalping

Scalping is a trading strategy that specialises in taking profits on small price changes. A position is usually only held for seconds to minutes and sold quickly when a profit target is reached. It requires continuous close attention to the market and precise timing. A scalper could make tens to hundreds of trades in a day and make small amounts with each trade. Cutting losses is important as one trade that goes against can easily wipe out all your small wins.
I wouldn’t recommend trying to scalp in your live account when learning. Do it in your demo account as you can very quickly go through your capital.

Hours to Days: Day, Swing or Pivot Trading

This strategy involves looking at the daily oscillations of a market and then looking to take a position when a pattern is confirmed. To do this you need to have some understanding of a few technical analysis patterns and then wait for the right moment. Your target for these types of trades are usually the other extreme of pattern. Traders who use this strategy can expect their account to move up in a steady predictable pattern with no excessive wins or drawdowns.
This is a good strategy to use as you can plan a few trades in advance and then wait for the right conditions which should come along every few days. These trades should have a reasonable risk/reward ratio (3 to 1 or more). You patience so as not to burn through your capital while waiting for the entries.

Weeks to Months or Years: Trend Trading

Trend trading is considered the most profitable. This strategy can be effective as each position you hold can end up being x10 or x100 of your original risk amount so with a couple of these trades your account can easily double or triple in size.  The challenge with trend trading is that markets are generally only trending for 30% of the time and then ranging for 70%. For this strategy patience is crucial. A trend trader’s account can swing quite dramatically with large drawdowns while waiting for the right opportunity and then doubling or tripling in a short time when a good opportunity comes.
This is an excellent strategy as each trade has an excellent risk reward ratio (20+ or more). The challenge is that these opportunities don’t come around often. You are either waiting for months or years to take a position or you take positions which aren’t trending and burn through alot of your capital. This is a good strategy to complement swing or pivot trading as you can take a position in the direction of the trend and move your stop so that if it continues on then you still hold the position. If it swings back then you take your profit.

The CFD Traders Journey

The path from new trader to rich trader, sourced from NewTraderU – 40 Steps In The Trader’s Journey.

  1. We accumulate information, we learn- buying books, asking questions, maybe going to seminars and researching what really works in trading.
  2. We begin to trade with our ‘new’  found knowledge.
  3. We make profits only to give it back very quickly and then realize we may need more knowledge or information.
  4. We accumulate more information.
  5. We switch the stocks we are currently following and trading.
  6. We go back into the market and trade with our improved system. this time it will work.
  7. We lose even more money and begin to lose confidence that we can even be traders. The reality of losing money sets in.
  8. We start to listen to other traders and what works for them.
  9. We go back into the market and continue to lose more money.
  10. We completely switch our style and method.
  11. We search for more information.
  12. We go back into the market and start to see a little progress.
  13. We get ‘over-confident’ in a single trade and put on a big position believing it is a sure thing and the market quickly takes our money.
  14. We start to understand that trading successfully is going to take more time and more knowledge than we ever anticipated.
  15. We get serious and start concentrating on learning a ‘real’ methodology.
  16. We trade our methodology with some success, but realize that something is missing.
  17. We begin to understand the need for having rules to apply our methodology.
  18. We take a sabbatical from trading to develop and research our trading rules.
  19. We start trading again, this time with rules and find some success, but over all we still hesitate when we execute.
  20. We add, subtract and modify rules as we see a need to be more proficient with our rules.
  21. We feel we are very close to crossing that threshold of successful trading.
  22. We start to take responsibility for our trading results as we understand that our success is based on our ability to execute our methodology.
  23. We continue to trade and become more proficient with our methodology and our rules.
  24. As we trade we still have a tendency to violate our rules and our results are still erratic.
  25. We know we are close.
  26. We go back and research our rules.
  27. We build the confidence in our rules and go back into the market and trade.
  28. Our trading results are getting better, but we are still hesitating in executing our rules.
  29. We now see the importance of following our rules as we see the results of our trades when we don’t follow the rules.
  30. We begin to see that our lack of success is within us (a lack of discipline in following the rules because of some kind of fear) and we begin to work on knowing ourselves better.
  31. We continue to trade and the market teaches us more and more about ourselves.
  32. We master our methodology and our trading rules.
  33. We begin to consistently make money.
  34. We get a little over-confident and the market humbles us.
  35. We continue to learn our lessons.
  36. We learn smaller positions lower the volume of our emotions so we trade smaller and this surprisingly makes us better with our discipline.
  37. We learn that risk management is one of the biggest keys to winning as a trader, we start to understand that big losses will make us unprofitable so we finally trade a smaller and consistent position size.
  38. We stop thinking and allow our rules to trade for us (trading becomes boring, but successful) and our trading account continues to grow as we increase our position size only as our account grows.
  39. We are making more money than we ever dreamed possible.
  40. We go on with our lives and accomplish many of the goals we had always dreamed of. Money is our new tool to do what we have always wanted.

 


CFD Trading Books

Ok so these aren’t book specifically about CFD trading but they’re classics all the same.

 


CFD Trading Videos

Same with the videos. These aren’t about CFD trading specifically but they are interesting, fun and should give you something to do watch when the markets are closed.

 


CFD Trading Websites & Resources

There are so many trading websites & resources online the challenge is finding quality. This list is short but it’s the few that give you the most value, information and cost you nothing.

  • www.tradingview.com
    TradingView is an amazing website that not only gives you powerful free web-based charting tools with all of the features you could dream for it also has a social sharing aspect to it. Take a look at the most agreed ideas for this week.Traders can post a trading idea on a chart and share it to the community with their analysis. This shows you how diverse ways that people are using to interpret and understand the markets you are interested in.While you are learning it is helpful to look at what other more experienced people are looking for and what conditions they are waiting for to confirm the trade. Traders can’t delete ideas that are posted and you can press the play button to see if what the anticipated played out as expected.Personally I found anilangal’s analysis and insight extremely valuable. He manages a team of traders for a living and also is very open. I learned from him how markets move in waves and how the impulse wave is the one that you want as the correction moves sideways in a choppy motion. I learned what a buy setup and sell setup for these opportunities looks like and he even was doing free trading webinars where he explains things in more detail. All for free 🙂
  • tradeciety.com
    A fantastic resources for retail traders with a blog, trade review & a free trading academy:

  • newtraderu.com
    Steve & Holly Burns’ website focused on helping retail traders, check out the great free resources on chart patterns, psychology, risk management and lots more.
  • tradingwithrayner.com
    Alot of valuable resources here for beginners. One of the posts I found very useful is trend following.

 


CFD Trading Quotes & Sayings

  • You either make money or you learn something
    Not sure where I heard this quote but you’re paying for you tuition each time you lose so you better learn something or your school fees can get expensive!
  • You know you’re doing it right if you are hands are numb from sitting on them
    I read this one in the TradingView chat and it resonated with me. You make most of your money waiting. Not over-trading when no opportunities are there and then not fiddling with trades that are doing well.
  • Let your winners run and cut your losses
    A classic Wall St. quote. Strangely enough most people feel the urge to do the opposite. You need to fight that urge!
  • “There is only one side of the market and it is not the bull side or the bear side, but the right side” – Jesse Livermore
  • “Emotional control is the most essential factor in playing the market. Never lose control of your emotions when the market moves against you. Don’t get too confident over your windows or too despondent over your losses.” – Jesse Livermore
  • “A man must believe in himself and his judgements if he expects to make a living at this game. That is why I don’t believe in tips” – Jesse Livermore
  • “Don’t trust your own opinion and back your judgment until the action of the market itself confirms your opinion.” – Jesse Livermore
  • “It’s not the mountain we conquer but ourselves” – Edmund Hillary
    A great quote that sums up extremely challenging endeavours. Success is there for anyone but only people who can deal with personal challenges, setbacks & disappointments and still continue have a chance of succeeding

 


Getting Started with CFDs

I would recommend starting with trading in a demo account to familiarise yourself with execution and start to experiment with position sizing, stop losses and different markets. If you decide to open a live account and deposit money then please be aware that your capital is at risk.

  1. Choose a Broker
    Here are 10 of the best currently in the market to choose from:

    1. IG Index
    2. CityIndex
    3. eToro
    4. ETX Capital
    5. IronFX
    6. Plus500
      A trader with a Plus500 account can trade CFDs on Forex, Stocks, Commodities , Options and Indices. Plus500 UK Ltd is authorised and regulated by the Financial Conduct Authority (FRN 509909).
    7. London Capital Group
    8. FXTM
    9. UFX
  2. Provide the required details to sign up
    In some countries you may need to provide a scan of your passport.
  3. Deposit your starting capital
    Each broker has different starting capital requirements. I would suggest depositing the minimum amount to start with.
  4. Ideally take your first trades in a demo account and only progress to a live account once you understand the basics.

 


Frequently Asked CFD Questions

What is XXX / What does YYY mean?
For definitions of terms check out the glossary below.

What is CFD Share Trading, what is CFD Stock Trading?
CFD trading is offered on a variety of assets. Shares or stocks can be traded using CFD’s which gives you two things that you can’t get with standard share/stock trading. The first is leverage and the second is the ability to short. CFD provide a way for you to hedge your real shares to protect your downside or just to speculate. With CFD Share Trading you don’t own the underlying assets, you do pay or receive dividends but you can’t vote or receive franking credits.

What is a CFD Trader?
A CFD trader is a person or company involved in trading CFD’s. CFD traders have access to a wide range or markets worldwide including shares, foreign exchange, indices, commodities and crypto currencies.

Is CFD trading gambling?
It can be helpful to think of all types of trading as gambling. With gambling there are punters who have gamble on emotion & hunches and there are professionals who manage risk, their money and their emotions. You want to be the professional gambler, not the punter. Trade with a plan and manage your risk & money according to that plan.

How does CFD trading different from share trading, spread betting and binary options?
With share trading you own the underlying stock, it’s done without leverage and selling short either isn’t possible or not very easy to do. Spread betting is a derivatives product that allows you to trade on the price movements of securities. Depending on your residence spread betting can be tax free whereas CFD’s are subject to tax. Losses incurred with CFD’s can also be made as a tax deduction.

Does your broker always hedge your position?
Market maker brokerage accounts generally don’t need to hedge for retail traders as much as you think for the following reasons:

  • They have many clients taking positions each way so they automatically hedged a certain amount.
  • They also have quite clever software algorithms to identify which traders and trades are most likely to lose based on the characteristics of successful traders (frequency of trading, position size, account size, stop size).

The combination of these factors and their risk appetite for a given market would give them how much they would be need to hedge.

They expect new traders to give up most of their money until they start to trade in a more consistent & disciplined way.

Experienced traders and those who are “swinging a big line” are much more likely to win and/or if they do they will win big. For these they would hedge most of it and earn their money from the commission, spread and interest.

For DMA brokerage accounts you place orders directly into the order book so the brokerage is always hedged.

Can you trade penny stocks with CFD’s?
Most brokers usually only provide access to markets the meet certain minimum market capitalisation. Some penny stocks meet the requirements but most don’t. The brokers will also reduce the risk by providing far less margin than for other securities. Both CFD’s and penny stocks are high risk so combined you are taking the risk to nose bleed levels. Proceed with caution!!

Are CFD’s suitable for ‘set and forget’ or “buy and hold” investments?
Definitely not. Because of the leverage and volatility of the markets CFD trading requires regular attention. You are also paying daily interest on the leveraged positions so a stock that doesn’t move much may end up costing you money due to the interest payments.

Will it be a problem if I don’t have much time to manage my investments?
Probably, because of the leverage and volatility of the markets the timing of your positions is critical. However, f you trade with lower leverage and stick to the daily charts you could create entry or exit orders or take your positions and then leave it for the day. Each day you could spend a little time reviewing those positions. If you want to trade higher leverage with tight stop losses then the window of opportunity for opening positions will not be very long.

I’m new to investing, should I start with CFD’s
Probably not. For most people CFD’s are going to going to require too much risk and effort to learn how to do it properly. An investment portfolio should have a large foundation of low risk assets which form the bulk of your wealth. CFD’s and other high risk strategies should only be done with a fraction of your overall portfolio as the most likely outcome is that you will lose the money that you trade with. Therefore CFD trading needs to be done with money that you can afford to lose.

How does the broker make money. Do I get charged commission for buys & sellsBrokers make their money on the spread, on the interest they charge for holding leveraged positions overnight and on trade commissions. Brokers may also choose to not hedge your position.

How are CFD’s taxed?
For Australians this topic is covered well on thebull.com.au.

Do CFD’s have an expiry or end date?
No. This is one of the attractions of of CFD’s, they are much simpler to understand than some other instruments that have an expiry date.

Are CFD’s legal in the USA?
No. They are not permitted to US residents & citizens due to restrictions by the Securities and Exchange Commission on over-the-counter financial instruments. The only exception in the USA is forex trading as there is no regulated exchange there for foreign exchange. So you can trade forex with CFD’s but not gold, oil, commodities or securities.

What happens if your CFD stock gets suspended from trading or goes under?
When a CFD stock is suspended from trading you will be unable to close open positions or take new positions in that stock. You will still be charged interest if you are long and receive it if you are short. A suspension or trading halt may be due to something temporary like an announcement after which the stock is traded again on the market. When reopening the price may have gapped either in your favor or against you. If a business goes into administration then if you are long you would be liable for the full value of the shares held and if you are short you could potentially receive the full value in payment(as determined by your CFD provider).

What happens if you are holding positions at dividends time?
If you hold you a share CFD immediately prior to the market open, on the morning of that share’s ex-dividend date, you account will have a dividend adjustment. You will get a positive adjustment if you are long and a negative adjustment if you are short. Note that you while you receive the dividend adjustment you don’t own the underlying shares so you don’t get voting rights or franking credits. Australian traders can find a more detail explanation here.

Why do stocks have a “buy only” status?
For a broker to offer the ability to short sell a stock they need to be able to borrow the stock from somewhere first. For a variety of reasons they may not be able to borrow it so they disable the ability to short the stock.

How do CFD’s compare to binary options?
A binary option is based on a simple yes or no proposition. You take a bet whether you think a price will be above a certain price at a certain time. If you win you get a fixed amount and if you lose you get nothing. If you are serious about making money trading in the markets then DO NOT use them. The principles behind successful CFD trading aren’t possible with binary options. With CFD’s you can lose 60% of the time but still be profitable if the winners make more than the losers lose.

How do CFD’s compare to spread betting?
CFD’s and spread betting have alot of similarities. Both products are derivatives that can be used to trade a wide range of securities. They are treated different from a tax perspective. Spread betting is used to

Is it possible to win against High Frequency Traders(HFT)?
High Frequency Traders are systems and algorithms that are opening and closing positions at an extremely high volume. They use a strategy that the retail trader would never be able to replicate or compete against. That doesn’t mean you can’t be a successful trader, you just need to use a different strategy. The HFT strategy is short term and reactionary. If you are looking at the the fundamentals of a market, at the trends and then trading those you will be able to succeed against them. The trading algorithms are powerful but they are far from perfect, a key flaw I see is that they are unable to take context into their decisions.

A recent example that comes to mind during an oil glut in 2016 when a hurricane stopped the unloading of cargo. The data released the next week showed that there was a massive reduction in inventory which made sense given all the boats were stuck unable to unload. The HFT’s saw the data and spiked the oil price massively which was an opportunity to fade knowing that the the inventory hadn’t really dropped it had just been stuck out at sea.

 

 


CFD Trading Glossary

When you enter the world of trading financial securities and CFD’s you will find that there are many terms that you need to become familiar with. These are the terms that are used in this post and also other terms that you will most likely need to know first.

Average Down
This is an unsuccessful strategy which describes adding to losing positions. It goes against the key principle of cutting your losses.

Average Up
This is a successful strategy which describes adding to winning positions.It allows you to magnify your winnings when a trade is going as you expect without also compounding your risk(ie. by increasing your position size at the start). Also known as scaling in or pyramiding.

Ask
The ask price represents the minimum price that a seller or sellers are willing to sell a security. This is the quoted price at which someone can buy; The opposite of Bid.

Bear
Someone who believes the price of a security will decline in value. The opposite of a bull.

Bid
The bid price represents the maximum price that a buyer or buyers are willing to pay for a security. This is the quoted price at which someone can sell. The opposite of Ask.

Binary Options
A financial option in which the payoff is either some fixed monetary amount or nothing at all.

Black Swan Event
Is a metaphor that describes an event that comes as a surprise and has a major effect. They are extremely unlikely but extremely high impact events.

Bonds
Bonds are a form of financial investment that involve lending money to an institution for a fixed period of time. They usually come in two varieties: corporate bonds and government bonds.

Broker
A broker is an individual or company that places trades on behalf of a trader. They can do in a variety of different asset classes.

Bull
Someone who believes the price of a security will increase in value. The opposite of a bear.

Buy Order
An instruction to buy a security at a different price to where the market is currently trading.

Commodities
Commodities are raw materials or primary agricultural products that can be bought and sold. A commodity is essentially the same quality across producers so it can be bought and sold on a central market or exchange.

Counterparty
The other party in a financial transaction. Counter party risk is one of the risks of trading CFD’s.

Dividend
A dividend is money paid periodically by a company to it’s shareholders out of it’s profits or reserves. If you hold a CFD position at dividend time you will receive a payment into your account if you are long and withdrawal if you are short.

Direct Market Access (DMA)
Direct market access (DMA) is a term used in financial markets to describe electronic trading facilities that give traders wishing to trade in securities a way to interact with the order book of an exchange. CFD brokers usually offer either Market Maker of Direct Market Access. Many traders believe that using Direct Market access is a way of reducing the risk that the broker is taking advantage of the trader.

Derivative
A derivative is a financial product that enables traders to speculate on the price movment of assets without purchasing the assets themselves. Since no underlying assets is being traded when derivative positions are opened, they usually exist as a contract between two parties.

ETF
Stands for Exchange Traded Fund, a type of investment security that is bought & sold on exchanges.

Equity
In trading equity usually refers to your combined total cash and profit(or loss).

Execution
In trading, execution is the completion of a buy or sell order from a trader. It is carried out by a broker.

Exposure
Exposure in trading is a general term that can mean three things:the total market value of your trades at open, the total amount of possible risk at any given point, or the portion of a fund invested in a particular market or asset.

Fill
Execution of an opening or closing order.

Forex
Is short for Foreign Exchange. Used as a general term to reference the trading of currency pairs.

Fundamental Analysis
Fundamental analysis is about studying everything from the overall economy and industry conditions to the financial condition and management of companies.
This is and other analysis types are covered in more detail in the CFD Trading Analysis section of this post.

Futures
Are a financial contract where the buyer & seller agree to exchange a security at a predetermined price date and price. They evolved to help famers and dealers being able to predict their costs or income in advance.  Not long after they started being used by speculators who had no interest in taking delivery of the commodity.  

Gap
Where the market trades through a level specified by an order by the trader. This can occur in fast moving markets, in news events or when markets are closed. This is one of the risks of trading CFD’s.

Geared
Another term that means leverage. Like increasing the gears in a bicycle where you can get more speed for the same effort. You can increase your leverage and get more gains(or losses) with the same capital.

Guaranteed Stop Loss (GSL)
For an additional fee a broker my provide a guaranteed stop order. If the market were to gap then the broker would close at the level you specified and would pay any additional costs themselves.

Hedging
A transaction that reduces risk.

Index
In trading, an index is a grouping of financial assets that are used to give performance indicator of a particular sector.

Initial Margin
Initial margin is the percentage of the purchase price of securities (that can be purchased on margin) that the investor must pay for with their own cash or marginable securities; it is also call the initial margin requirement. This is covered in more detail in the Margin and Exposure section.

Leverage
Leverage is a concept that allow you multiply your exposure to a financial market without committing extra investment capital. This is also known as gearing.

LIBOR
The London Interbank Offered Rate is a benchmark that dicates daily interest rates on loans & financial instruments around the world. These rates are often what brokers will use when charging you interest for your leveraged positions.

Liquidity
Liquidity describes the degree to which a security can be quickly bought or sold in the market at an efficient price without affecting the asset’s price. Cash is the most liquid, while real estate, fine are and collectibles are relatively illiquid. Markets that aren’t liquid are considered to be higher risk as when you need to transact you can’t without taking a significant reduction in the value.

Long
To buy a security with the expectation to make money if it goes up in value. You buy first and then sell to close the position. The opposite of shorting. This is covered in more detail in the Going Long or Short section.

Lot
A standard trading term referring to an order of 100,000 units. Currency pairs are usually traded in unites of 100,000(standard lots), 10,000(mini lots) or 1,000 micro lots meaning buying / selling 100,000 of the base currency while selling / buying the equivalent number of units in of the counter currency.

Maintenance Margin
The maintenance margin is the percentage of funds required to keep your position open. Also known as variation margin. This is covered in more detail in the Margin and Exposure section.

Margin
The amount required to open and maintain a leveraged position. Similar to a deposit when purchasing a house. This is covered in more detail in the Margin and Exposure section.

Margin Call
If your equity goes below a threshold your broker may request that you enter additional funds to keep your positions open. In fast moving markets and with electronic trading a broker may automatically close positions. This is covered in more detail in the Margin and Exposure section

Market Makers (MM)
A market maker is a dealer in securities who undertakes to buy or sell at specific prices at all times to facilitate liquidity. With CFD’s they have particular importance as brokers generally offer two models, Direct Market Access(DMA) and Market Marker(MM). When a broker acts as a market maker they may choose not to place your trade or hedge the position that you take in the underlying market. If you are trade with a successful track record then they are likely to hedge or take positions in the underlying markets when you trade, otherwise they will lose money. However, it’s likely that most new or inexperience retail traders who trade with a market maker broker will not have their positions hedged in the underlying market. Many people believe that this creates a conflict of interest where the broker has a vested interest in your trades failing. The mitigation of this is to use Direct Market Access where you are dealing directly into the underlying market.

Option
An option is a contract that gives the buyer the right, but not the obligation to buy or sell an underlying asset at a specific price on or before a specific date. The buyer has the option to let the expiration date go by and lose their deposit.

Order Book
The order book is the list of orders(manual or electronic) that a trading exchange uses to record the interest of buyers and sellers in a security. A matching engine uses the book to determine which orders can be fulfilled. With a Direct Market Access broker you can trade directly into the order book. Market Maker brokers may not execute the trade in the exchange when you place an order.

Penny Stock
A shares of small public companies that trade at low prices per share. They are popular because they only take a small amount of capital and small movements in penny stocks to create large changes in your profit or loss. They are notoriously volatile, have poor liquidity and have a reputation for being involved in “pump and dump” scams. They generally aren’t available to trade as CFD’s as brokers usually have a market cap limit which a market must exceed for them to include them.

Pip
Point, pip & tick are terms used to describe price changes in financial markets. A pip, “price interest point”, is the smallest price move that a given exchange rate makes based on market convention. One pip is equivalent to 0.0001.

Point
Point, pip & tick are terms used to describe price changes in financial markets. A point is the largest price change of the three measurements. It refers to the changes on the left side of the decimal. For example a price change for a stock from $125 to $130 as a five point movement.

Pyramiding
This is a successful strategy which describes adding to winning positions. It allows you to magnify your winnings when a trade is going as you expect without also compounding your risk(ie. by increasing your position size at the start). Also known as averaging up or scaling in.

Resistance Level
Resistance is the price level where supply is thought to be strong enough to prevent price from rising further. The opposite of resistance is support.

Scale In
This is a successful strategy which describes adding to winning positions.It allows you to magnify your winnings when a trade is going as you expect without also compounding your risk(ie. by increasing your position size at the start). Also known as averaging up or pyramiding. 

Scale Out
Scaling out is the opposite of scaling in or pyramiding. Rather than closing a position completely at a target you close a percentage of the position, locking in some profits while allowing the remainder of the position to hopefully continue to greater profit.

Scalp
A trading strategy that attempts to make many profiles on small price changes. This is covered in more detail in the CFD Trading Time Frames section.

Security
In a financial context a security is a certificate or other financial instrument that has monetary value and can be traded. Securities are generally classified as either equity securities, such as stock and debt securities, such as bonds.

Sell Order
An instruction to sell at a different price to where the market is currently trading.

Share
In financial markets a share is a unit of ownership to account for various investments. Corporations issue shares which are offered for sale to raise capital.

Short
To sell a security with the expectation to make money if it goes down in value. You sell first and then buy to close the position. The opposite of going long. This is covered in more detail in the Going Long or Short section.

Slippage
Describes a situation where illiquid market conditions mean a trader transacts at a worse rate than they had expected. When stop loss or entry orders are triggered the order is filled at the next available price assuming there is the required volume. If the market is illiquid, the order will be filled at a worse level than that requested by the trader – this is because there isn’t enough volume in the market to fill the order at the designated level. The difference between the requested level and the fill level is referred to as slippage. This is one of the risks of trading CFD’s.

Spot Price
The spot price is the price at which a commodity could be transacted and delivered on right now. This is in contrast to the futures or forward controls. The spot price of gold refers to the price of one ounce of gold and the spot price of silver refers to the price of one ounce of silver.

Stop Loss Order
A stop loss order is an order to execute a trade when a security reaches a certain price when moving in an unfavourable direction. It is used as a risk reduction mechanism so that a trader can control how much money they would lose if they are wrong.

Spread
The difference between what buyers are willing to pay what sellers are asking for in terms of price.

Spread Betting
Spread betting is a type of speculation that involves taking a bet on the price movement of a security. A spread betting company quotes the bid and offer price(also known as the spread) and investors bet whether the price of the underlying security will be lower than the bid or higher than the offer. The investor does not own the stock, they simply speculate on the price movement of the stock.

Support Level
Support is the price level where demand is thought to be strong enough to prevent price from declining further. The opposite of support is resistance.

Suspended Trading
Suspended trading is where there trading in a security is stopped for an extended period of time. This often occurs before major news announcements.

Swing Trading
Swing trading is a short term trading method where positions typically last more than a day but less then a couple of weeks. Swing trading is covered in more detail in the CFD Trading Time Frames section.

Technical Analysis
The focus of technical analysis is to focus on the statistics generated by market activity and the price patterns that form on charts as the primary source of information. This and other analysis types are covered in detail in the CFD Trading Analysis section of this post.

Tick
Point, pip & tick are terms used to describe price changes in financial markets. Like a pip a tick denotes a market’s smallest possible price movement to the right of the decimal. A price change then from 1.2345 to 1.2346 would represent one tick. Tick don’t have to be measure in factors of 10. For example a market might measure price movements in minimum increments of 0.25. For that market, a price change from 300 to 301 is for ticks or one point.

Tom-Next
In currency transactions, Tom-Next is the purchase and sale of a currency made to avoid taking actual delivery of the currency. The current position is closed out at the daily close rate and re-entered at the new opening rate the next trading day. Also referred to as the “tomorrow next procedure”.

Trailing Stop Loss
A training stop is an order to buy or sell a security if it moves in an unfavourable direction. Trailing stops automatically adjust to the current market price of a stock.
Treasuries
Tresuries are tradable and negotiable debt obligations issued by a companies government. They come with a guarantee by the government so they are considered very low risk. There are three types of securities issued by the US Treasury (bonds, bills and notes) which are distinguished by the amount of time from the initial sale of the bond to maturity (between one and ten years).

Trend
A trend is the tendency for a financial market to move in a particular direction over time. A bull market would be trending up and a bear market would be trending down.

Variation Margin
The variation margin is the percentage of funds required to keep your position open. Also known as maintenance margin. This is covered in more detail in the Margin and Exposure section.

Volatility
In finance, volatility is the degree of variation of a trading price series over time as measure by the standard deviation of returns.

Volume
The trading volume is the amount(total number) of a security that were traded during a given period of time.

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