What
are CFD’s?
Basically CFD’s are kind of like an instant margin loan, providing you with high leverage. This is basically how it works:
Lets say I want to buy $10,000 worth of shares in a stock that is trading at $1.00. For my $10,000, I will get 10,000 shares, right? However, most CFD providers only require you to pay 10% margin, so that means, for 10,000 shares, I would only need $1,000 ($10,000 x 10% = $1,000). If I wanted to invest the full $10,000 into CFD’s, I would be able to buy 100,000 shares, or $100,000 worth of CFD’s for my $10,000. This is where the benefits come, but be careful, this leverage works against you if the trade fails. Lets say the stock moves up by 5cents. 10,000 shares would make you $500 profit, right? (10,000 x $0.05) ok, now with the 100,000 CFD’s, you would make $5,000 because 100,000 x $0.05 = $5,000. So essentially you are making 10 times the amount you would normally, for the same amount of cash invested in the trade.
As is the case with all leveraged instruments, the risk of loss is also magnified. In the above example, 5cents move against you will cost you $5,000. When entering a trade of such size, you need to make sure you have enough extra cash in your account to cover any initial moves against you – lets face it, it’s pretty tough to get the absolute perfect entry into a trade. So if you are entering the trade @ $1.00 and you only wish to give it 2.5cents “breathing room”, you would need at least $12,500 in your account for the trade, just incase it does move against you by that much. If you only had $10,000 in your account and you invested the full amount into the trade, as soon as it moves against you, the provider will be on the phone with a margin call, requesting you either put more money in your account, or they close out your position. If you are new to CFD trading, your best approach is to just trade small positions at least until you get used to the power of leverage, because trust me, it can be very frightening if you have a large position going against you. Most providers do have guaranteed stops, but they charge you a fee for it.
Interest: This will vary, but most will be a percent or two above the standard variable rate on the full value of your trade! So, on the above example, if I was to trade the $100,000 positon the interest charged would be calculated roughly like this: Current interest rate is roughly 7%, lets say for example this particular provider charges 9%, I would be charged $9,000 interest if I was to hold the trade for a year. But, I’m not going to hold the position for a year, so I divide that figure by 365 to get the daily rate, in this case its roughly $25 a day for interest.
Commissions: Once again these will vary. Usually anywhere between 0 .1% of the full value of the trade to up to 0.3% in some cases. Lets say we use a provider who charges 0.2%, that’s $200 entry for a $100,000 position, and if we make the $5,000 profit, then the position size is $105,000 on exit, so that would be $205, total commissions paid would be $405. net profit for the trade would be $4,595 (45.95%) from a $10,000 investment. Had you only bought your $10,000 worth of shares and sold them @ $1.05 as we did above, then you would have only made $450 (4.95%) after commissions. Bear in mind some providers will also give discounts for high volume traders. My provider usually charges 0.2%, but because we are high volume traders, we only get charged 0.08% - a saving of more than 50%.
Monthly platform charges: Some providers may charge a monthly fee to use their trading platform – usually around $100 per month.
First and
foremost: It is ESSENTIAL that you choose a provider that uses a DIRECT
MARKET ACCESS (DMA) platform ! What this means is that your trade is placed
on the REAL market, not one that they “make” – otherwise known as
“market makers” If you use the DMA platform, you can see what is available
to buy or sell to on the REAL market. A common trick with “market makers”
when you go to buy your CFD’s, they will “requote” you a higher price than
what is available on the real market – they are essentially RIPPING YOU
OFF!
Different
providers will suit different people better - it depends on the individual.
Since you are just starting out in CFD's, i imagine that you'd be only opening
an account with a small amount of capital - at least until you get a feel for
trading with leverage. There's many providers around all with varying costs and
charges. Do some shopping, and ask them the following:
Is their platform DMA? (direct market access)
Can you participate in open and closing auctions?
Do they have any monthly charges?
what are their commission rates?
what do they charge for interest?
do they pay interest on short positions? if so, at what rate?
My advice - go to google.com and search pages from Australia for "CFD
providers" and find which one best suits you.
I can't reccomend any in particular as this is a non profit site.
Before you start trading CFD's it really is essential that you fully understand how powerful the leverage is, and remember, that leverage can work against you, aswell as for you. It's essential to have good money management skills, and be able to admit you've got it wrong immediately if a trade moves against you. For practice, you can download a little spreadsheet that i've made, all you need to do is fill in the entry price and adjust the exit price as the trade moves to see your net position. Bear in mind this is only to be used as a rough guide for practice.... it wont be completely accurate, but its good enough to get the feel of how leverage works.
Download it HERE