How to Trade CFDs

The popularity of trading CFDs has taken around the world by storm. There would have been very few people in the invesment community that could have predicted the success of this leverage product and even during the economic downturn, some of the leading CFD brokers are increasing trade volumes.

Largely the popularity of CFDs in Australia is the simplicity of the product itself. Contracts for difference or CFDs are exactly equal to the sharemarket trading, except that you need a small amount of money in advance.While the CFDs are a product of leverage, the amount is up to the users. This means any trader could make the trade as safe or as risky as that choose.

1,000 new accounts a month during the bull market

At the top of the bull market it was fairly common for some of the major CFD brokers in Australia to be opening around 1000 new accounts each month.During 2008 the world stock markets experienced a high level of volatility. Though this extreme many CFD brokers in Australia experienced the highest level of trade volumes and the largest number of openings for account at any time in its history.

Using CFD coverage and to reduce the volatility of the portfolio

One of the reasons for the increased interest in CFD trading in Australia is due to the fact that CFD can actually be used as a tool of coverage and allow investors to reduce their risk in theor existing share portfolio. As any trader knows the increased volatility comes from an increase in the number of opportunities.

So as you can see the popularity of Trading CFDs Australia has grown. Remember other derivatives such as options, warrants, and futures will remain good products to trade forward.



CFDs permit people with little quantities to get much more safely started within the market by growing their diversification. By using CFDs, we only have to put up a fraction of our capital to obtain the same exposure on the stock than if we had purchased shares through our share broker.

We believe, in general terms (and up to a limit), the more trades you have exposure to, the better that you will do in the long run. This is simply because getting your money spread across as many stocks as feasible (within reason) will improve your diversification in the market, and as a result decrease your risk.

With CFDs, $100 successfully has $2,000 investing power within the market. Numerous traders only have $2,000 to invest in the first place. You cannot get much diversification with $2,000 – the dangers to this little quantity of capital are therefore massive. Not to mention the %age that commissions and costs will eat up on such a little quantity.

With CFDs, however, our little $2,000 gets as much as $40,000 investing power in the market. This means you can purchase as many as 20 trade ideas (in theory) in CFDs. If carried out properly, it is really much less risky to purchase CFDs – simply because we can get much better diversification.

For this wonderful diversification your CFD provider will demand a number of fees. A number of these fees are the same as you would spend if you had been investing in shares, but some are a small different.

The costs that are generally associated with CFDs are:

Trade Commissions – generally charged as a flat rate up to a particular trade dimension, and then a percentage of the trade size following that.

There are a number of CFD companies. We use IG Markets as they appear the cheapest, the charges beneath are depending on IG.

Minimum commission: $1 (on-line trades), $10 (telephone)

Or else: 0.1% of total value of trade.

E.g. 1:
We put down $100, and get exposure to $2,000 worth of share.
Commission – $10.

E.g. 2:
We place down $1,000 and get exposure to $20,thousand worth of share.
Commission – $20 (0.1% x $20,thousand)

Funding – for that benefit of only putting up a fraction from the trading capital, our CFD provider will charge us a funding charge if we buy, and pay us an interest rate if we are short.

Let us clarify.

We put up 5% of the transaction. Our CFD provider effectively loans us the other 95% so we are able to gain the benefit of full ownership from the shares. They’ll demand an interest rate over the loan amount. This rate is 2.0% pa above the cash rate. The quantity is calculated daily. So, if we place down $100, and get exposure to $2,000 worth of stock, our CFD supplier will charge us 7.5% x $2,000 / 365 per day. This is 41 cents each day. If you were to hold the position for three months, financing this position would cost $37.

This is the cost of diversification.

You need to decide whether 41 cents each day, every $2,000 position, is greater than the risk of only being in a position to keep 1 stock in your portfolio with your $2,000. Let us say with your $2,000, you enter 10 trades. You can reap the benefits of getting ten stocks in your portfolio for $4.10 per day.

Now, there’s an essential point right here that we have to bring to our your attention. People thinking that 7.5% pa calculated daily is a large consideration, must also consider what your money should be making by permitting it to sit in your cash management account – instead of within the accounts of the individual you’d have otherwise purchased the shares off if you had gone via Komsec.

Purchase XYZ shares with Komsec – send them a cheque for $2,000. The zero balance of one’s cash management account is now earning 5.5% pa, which is, obviously, absolutely nothing.

Buy XYZ CFDs and only use $100. The balance of one’s cash management account is now $1,900 earning 5.5% pa. Whenever you look at it, while you are spending 7.5% pa on $2,000 for the CFD position, you’re nevertheless earning 5.5% on the $1,900 extra you would have in your money management accounts – cash you wouldn’t have had if you traded with Komsec.

So the price of financing, in practice, can be far less than 7.5% pa.

We think diversification is vitally important to every trader. The danger of holding shares in only one organization is substantial. In any case, every investor will need to assess the worth of diversification for themselves and whether CFDs are an suitable trading device for them.

You buy and sell CFDs just as you’d purchase shares. However CFDs are not shares but their prices will move almost precisely as the share they cover. So, BHP will have a CFD counterpart. In most instances, when the price of BHP rises by ten cents, then the BHP CFD will also rise by 10 cents. Rather than actually owning the underlying shares, you are only entitled to, or are liable for, the difference between your purchase price and your selling cost.

CFDs are leveraged items. You only place up a fraction of the notional share price to control the exact same amount of shares. The leverage offered by some CFD companies can be as much as 33 times, but is usually close to twenty times. This indicates that for $100, we get exposure to $2,000 worth of shares.

When purchasing CFDs, we successfully are placing up $100 in the transaction and the CFD supplier puts up the other $1,900. The CFD supplier then gives us the same exposure as if we had gone out and purchased $2000 shares on the Share Market ourselves.

For that opportunity of effectively borrowing $1,900, the CFD provider will impose on us an interest rate. This rate is usually the cash rate plus 2% or so, or around 7.5% pa.

Now, the great point about utilising CFDs to hedge is the fact that we are going to be sellers of CFDs. When we sell CFDs, the CFD supplier will usually pay us an interest rate from the cash rate less 2% or so, or around 3.5% pa.

Hedging with CFDs utilises the concept of short selling. When we short sell we’re trying to sell prior to an expected fall within the share price. Let’s say you own one,thousand AWB shares that are buying and selling at $6. It becomes public that management have been involved in some rather questionable deals with the former Iraqi Government. You anticipate AWB shares to tumble in price. To avoid the anticipated falls, you would sell AWB immediately right?

Precisely, which means you sell at $6 and get $6,000 back into your account. Let’s say that your hunch is correct and AWB shares tumble to $4. The scandal blows over, and you decide to buy back the AWB shares at $4 simply because they now appear cheap.

Now, it should be clear that by getting this quick action you’ve saved your self $2000. You still have one thousand shares of AWB as in the start of the transaction, but you’ve effectively made a notional profit of $2,000 – this quantity is still sitting inside your bank accounts after the transaction is finished.

Short selling uses the exact same concept. You are looking to sell 1st, and buy the share back again later following when it falls. The only difference with short selling from normal selling is the fact that we don’t need to own the shares prior to we sell them. In the above instance, we didn’t need to own the AWB shares to short sell them. With CFDs, we can simply sell them at $6, after which buy them back later on at $4. In this case, rather than making a saving we are producing earnings of $2,000.

So, that’s short selling. We like to think of the phrase “short” in this context: “Sure, I would like to buy you a drink after work, but I am a bit short today”. Short refers to not having some thing initially.

As we said above, selling a CFD is like selling the actual shares. The idea is that if we sell a CFD corresponding to the shares in our portfolio, and the price of these shares fall, the profit from selling the CFDs will compensate us from the tumble in the same shares we’re holding.

Cheap at one-twentieth of the Cost.

Let us use an example: For continuity, let’s use the AWB example above. AWB CFDs possess a leverage of twenty times. This indicates that to completely hedge our one thousand AWB shares worth $6, we only need to put up one-twentieth of the worth of AWB shares, or $300 to short sell 1,000 AWB CFDs.

So we put $300 aside in our CFD account and click the sell button for one thousand CFDs on our CFD trading platform. For all intents and purposes, short selling one thousand AWB CFDs is exactly the same as selling your actual AWB shares.

When AWB falls to $4 1 month later, we’ve of course lost $2000 on our share position. The good news nevertheless, is the fact that the value of our CFD accounts has risen by an equal and contrary quantity. Furthermore, we’ve actually accumulated some $17.50 in interest from our CFD provider for becoming short! So, actually, we have made a small net profit by using these CFDs to hedge.

What’s the downside? Well, as with something in life there is one – so don’t get too excited. If AWB shares rose, we would similarly make an equal and contrary loss on our CFD accounts from our CFD short placement, than we would make on the AWB shares from their cost increase. In the above instance, we would have lost $2000 on our CFD account. This would have to be financed from somewhere else – either selling a number of our AWB shares – our straight out of our back pocket!

An effective short term hedge.

So, there’s a trade-off for this quite efficient ideal hedge. Despite this however, shorter-term, targeted hedging strategies utilising CFDs are possibly the most effective techniques of hedging a share portfolio.

Let’s disect CFDs for all those novices present.

CFDs have grown to be an increasingly common investment strategy for Aussies. For people who are fresh to the market, however, CFDs can be challenging to grasp in the beginning.

Let’s get one thing straight: CFDS aren’t shares. In reality, CFDs have got all the advantages of trading stocks, without you actually needing to physically buy, own or sell the shares. They mirror the performance of a share, or an index.

CFDs are all concerning the difference. With CFDs, you are making a contract with a provider (like IG Markets or like CommSec) regarding the opening and closing price of a share or index you’re looking at.

You are making a deal with your CFD provider to exchange the difference between the opening and closing prices of your share or index. E.g. you think a company is going to crash. You’re able to contact your CFD provider to specify the price of the company’s shares (the start of the contract) and what level you think the shares will fall to (the end of the contract). In the case when you reach your target, the CFD provider pays out cash on the difference between the starting share price, and when the contract is closed.

Most participants only take on CFDs for a a couple of days or weeks. While CFDs are ideal for short-term trading, they’re bad for long-term trading, due to each day you maintain a position it costs money. It’s not really a lot of money each day, but it’s money all the same. Any time you buy or sell a share/index/tradable instrument, the standard fee is 10% of the price of the underlying shares.

It’s great that CFDs are much at a lower cost than buying and selling real shares, as you are always only trading on a margin. And there’s also the side benefit of acquiring access to the company’s dividends released in the course of the CFD’s life.

Nevertheless there’s downside, as well. Don’t forget CFDs are agreements, which means they are two-way. You acquire money if the price moves the way you think it does, unfortunately if it doesn’t you will need to compensate the CFD provider when you get out of the contract.

The “borrowing” procedure involved in CFDs also magnifies whatever profits and failures you make, so whilst you stand to make some decent money, you can potentially also lose more than you put down to begin with.

Much like anything in the financial game, CFDs have their advantages and disadvantages.