Many people have heard of CFD’s but not many know what they are.
A contract for difference (CFD) is a contract between a buyer and seller, stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time (if the difference is negative, then the buyer pays the seller instead.
CFD’s enable you to trade using a leverage of 10:1. This means you invest a tenth of the amount of the underlying asset.
Let us take an example, NAB. If we believe this share will rise from $29 to $32, we can purchase a CFD for 1,000 shares. If the share does rise by $3 to $32, our profit will be $3,000. This is calculated by the change in price of $3 times the number of CFD’s, namely 1,000. Your investment would have been $2900, made up of share price of $29, times 1000 contracts divided by the leverage of 10.
The advantages of CFD’s are as follows:
– It is cost effective because you can trade using leverage.
– you can trade on price movements without owning the asset.
– you can trade falling markets, by betting on the downward movement of a price
– you can receive dividends and participate in price splits
– you can trade shares, indices and market sectors
– you can trade 24 hour a day globally
– you can hedge a share you own in anticipation of a falling price, without selling your shares
– use stop-loss to minimize risk
Although it is possible to make 10 times as much money like in the example above, it is just as easy to lose 10 times as much if the price had fallen.
You therefor need to thoroughly consider the risks before making an investment decision.
STRATEGIES FOR FINANCIAL FREEDOM
It is important to consider what the length of your trade is going to be. These typically range from a few days to a few weeks per trade.
You therefor need entry and exit rules that will enable you to respond quickly.
One of the most effective rules that works with CFD’s is Gann’s counter-trend theory. You can use this theory to determine entry and exit points and stop losses.
For more information please see our detailed article on this subject by clicking here.
Entry, stop loss and exit points are covered in detail.
This point is about managing your capital and the risk you are prepared to be exposed to. For example, if you had capital of $100,000, and you are prepared to place 10% in high risk trades like CFD’s that means you capital available for CFD trades is $10,000. Furthermore, you should not risk more than 20% in any one trade, thus $2,000 per trade in this example.
For any stock market trading or investments stop losses should always be used. When trading CFD’s you should remember that your stop losses should be closer to your entry point but far enough to give the share trade some “breathing space” to unfold.
Also remember when trading CFD’s because of the 10:1 leverage, a 5% move is equal to 50% of your investment!
CFD’s is a high-risk trading strategy, but if you gain the knowledge, skills and experience it can be a highly profitable extension to your overall investment strategy.
Trades need to be managed regularly. It is not a “set and forget” strategy.
To learn more about gaining the knowledge and skills to be able to trade successfully, please click here.
For a comprehensive article on this subject by Dale Gillham, please click here.