Home The Pros and Cons Of CFD Trading

The Pros and Cons Of CFD Trading

In CFD trading, profit or loss on a position is determined by finding the difference between the opening price and the closing price. Most trading platforms have this format:  sell price on the left side and the buy price on the right side. You can learn more about CFD trading in this article.

Trading CFD—How It’s Done

The process of a CFD trade could be broken down into six stages, which are:

  1. Choosing the financial asset to trade– If it’s a currency you want to trade on, choose a pair, i.e. EUR/USD. CFD cuts across varieties of global capital markets and anything from stocks, commodities, shares, treasuries and forex can be traded.
  2. Choose between buying and selling– For every trade, you can only open one position: either a long position if you expect prices to rise (buy) or a short position if you expect prices to fall (sell).
  3. Determine trading capacity–The bulk of your potential profits or losses depends on the size of your trade. Before opening a position, first decide on the number of units you intend to trade. Note however, that a CFD unit varies with the financial asset being traded.
  4. Managing the risk–Do not trade until you have decided on a range of guaranteed stop-loss orders (GSLOs). The difference between an ordinary stop-loss order and a GSLO is that, in the case of a premium, they close you out of positions at a price that you specify irrespective of the market volatility. If GSLO isn’t triggered, then premiums are refunded in their entirety.
  5. Constantly observe your position–CFD trades are very volatile due to sensitivity to news releases. So you have to monitor your positions at all times, stop orders and take-profit orders included. This is the best way to keep track of your real-time profit/loss. Keep in mind that losses can go well above your deposits.
  6. Close your positionIf you didn’t set stop orders or take-profit orders, then the responsibility lies on you to close your position.

If you want to read more about the meaning of CFD and does it mean than we can highly recommend you to read this article on CFDs.

What Happens in a Typical CFD Trade?

Opening a Long Position (Buying)

Let’s assume a company XYZ Ltd trades a currency pair at 1499/1500p. You, the trader, have seen signs that the price will shoot upwards so you purchase 1000 units of CFD shares. XYZ Ltd.’s margin rate is 5%; meaning that you can open a position with a deposit worth 5% of the currency’s value.

This makes your long position worth £750 (1000 unit x 1500p buy price x 5%). Keep in mind that you may lose more than your deposit if the price falls.

Possible Scenarios

  1. Positive Trade: The better scenario: you predicted right, and the price of the currency pair soarsto 1525/1526p. The price has gone up 25p (1525-1500). Simply take 25 pence out and multiply it by the number of units you bought. That makes $250, your profit. 
  1. Negative Trade: The unwanted scenario: Your prediction goes awry and the price plummetsto 1459/1460p. Even worse, there is an indicator that the price will continue to fall, so you decide to cut short your losses and sell at 1360p, effectively closing your position. The price dropped by 41 pence (1500-1459) against your position. Multiply 41p by the number of units and your loss is £410.

Note: Margin requirements are only requisites to net open positions.

Opening a Short Position (Selling)

Still using the XYZ Ltd example, a specific currency pair trade at 1499/1500p. You, the trader, have seen signs that the price will plummet downwards so you plan to sell1000 units of CFD shares. XYZ Ltd.’s margin rate is 5%; meaning that you can open a position with a deposit worth 5% of the currency’s value.

This makes your short position worth £749.50 (1000 unit x 1499p buy price x 5%). Keep in mind that you may lose more than your deposit if the price rises.

Possible Scenarios

  1. Positive Trade (Profit): The better scenario: you predicted right, and the price of the currency pairfallsto 1459/1460p. The price has dropped 41p (1499-1460). Simply take 39 pence out and multiply it by the number of units you bought. That makes $390, your profit.
  1. Negative Trade (Loss): The unwanted scenario: Your prediction goes awry and the price soarsto 1525/1526p. Even worse, there is an indicator that the price will continue to rise, so you decide to cut short your losses and buy at 1526p, effectively closing your position. The price rose by 27 pence (1526-1499) against your position. Multiply 27p by number of units (1000) and your loss is £270.

 

Other Factors Involved in CFD Trading

Broker Commission

Every CFD share trade comes with a non-negotiable commission charge on every trade. In the UK, share trades cost 0.10%, i.e. 10 basis points; £9 being the minimum commission chargeable on any CFD trade.

You can calculate the amount of commission you pay on trade by multiplying the capacity of your trading position with the percentage commission rate. In the example above (XYZ Ltd), we can calculate the commission cost to open and close a buy position—commission rate at 0.10%.

One of the best CFD brokers are:

Plus500check the review here

eTorocheck the review here

CFD Globalcheck the review here

To open a buy position

0.10% x 1000 unit x 1500p = £15

To close a buy position

0.10% x 1000 unit x 1525p = £15.25

Holding Costs

Most times, trading positions have fixed expiration periods with fixed costs built into the asset price. Other times, when you hold a trading position after 5pm (New York Time), holding costs come into play. More often than not, the amount of holding costs you pay depends on the broker you trade with.