Before we jump into actual trade examples, it is useful to look at some common CFD trading terms:
Bid-Offer Spread
This refers to the difference between the buying price (bid) and the selling price (offer).
Stake or Trade Size
This denotes how many CFD contracts you are trading in a particular market. Buying or selling a stake is equivalent to buying or selling a CFD. Buying one stake or one CFD in effect means that each tick represents one unit in whatever the base currency of the underlying market is. For instance: if you bought 10 Spot Gold CFDs, each tick will be worth USD10 since USA dollars represents the base currency of the underlying Spot Gold market.
Tick
This denotes one unit of movement in contracts for differences. The size of a tick usually varies from .01 to 1.
Underlying Market
When you buy or sell a contract for difference, you are in effect making a contractual agreement with the CFD provider to trade the difference in the value of an underlying asset (sometimes referred to as ‘underlying security’ or the ‘reference asset’) between now and a future date. But you are not actually trading the underlying asset itself. So the term underlying market refers to the actual market on which you are trading on…for example trading a Spot Gold CFD means you are trading on the price movement in the actual Spot Gold market. It is important to know the base currency of the underlying market as that is the currency in which your profits/losses will be reflected.
Quote
This denotes the prevailing buy and sell prices for a particular financial instrument. Quotes are displayed as: sell price – buy price. For example, if 125.7 – 125.9 is the quote: 125.7 is the sell price and 125.9 is the buy price.
Finance
Financing is applicable on all CFD positions held overnight. The financing rate is applied to the full value of your position. If you hold a long ‘buy’ position you will be charged a financing interest, if you hold a short ‘sell’ position you may receive interest.
Mark to Market
A system whereby the value of an open position is revalued against the current market for the purpose of calculating variation margins.
Stop-Loss Order
This is an order placed against an open trade to limit a loss. In practice, setting a stop loss order means that you are able to automatically close trades and cut your losses if the market moves against you. Setting a normal stop loss is free of charge but there is no guarantee that you will be closed out at the exact price specified if the market jumps (gaps) through it. The stop is filled at the best available price once it is activated.
Guaranteed Stop-Loss
This does what it says. Guaranteed stop loss orders guarantee that you will be closed out at the exact price specified even if the markets jumps through your stop level. Unlike ordinary stop loss orders which are free of charge, there is a charge for using guaranteed stops.
Limit Orders
This consists of an order placed to enter a trade at a better price than what is currently available on the market or set a pre-determined price to exit a trade at a profit. Setting a limit order is free of charge but again there is no guarantee that you will be filled at the price you set if the market jumps through it. The order is filled at the best available price once it is activated.
Leverage
This is also known as gearing. It is basically the use of financial instruments or borrowed capital to magnify investment returns.
LIBOR
This is the London Inter-Bank Offer Rate. It is an interest rate at which banks can borrow funds from other banks. This is the UK equivalent of BBSW, SIBOR etc…
CFD Trading Example: Spot Gold
Let’s suppose you discover that the Gold market has been especially active as speculators keep pushing up the price – you think there is still room for further rises. The broker’s quote for Spot Gold is 952.1-952.6.
You buy 30 Spot Gold CFDs at 952.6.
Things to note:
- The tick size for Spot Gold is 0.1, so if Gold moves from 952.6 to 953.6, that is equivalent to 10 ticks.
- The base currency of the underlying Spot Gold market is USA dollars, so USA dollars will be the currency that you will be trading in.
In the next few days, you note that the Gold price has risen further and the broker’s quote is now 965.2-965.7. You decide to close your position by selling at 965.2.
This realises a profit of (9652-9526) X your stake of 30 = USD$3,780.
Note: In this example daily financing costs have not been included for simplicity.
