What is CFD Trading

CFD Trading Example

CFDs are often traded on what is called leverage [don’t worry we’ll get to this a bit later on] to give traders more trading power, flexibility, and opportunities. For the meantime, let’s just keep it simple with the following example:

The Agreement:

  • Person A believes Gold is going to rise from $1125 per oz
  • Person B believes Gold is going to fall from $1125 per oz

Therefore, the two clients enter an agreement to settle the difference from $1175.

The Outcome

  • Person A Buys 1 oz of Gold at $1125
  • Person B Sells 1 oz of Gold at $1125

After 4 days, Gold is trading at $1140 showing Person A profit of $15 on his oz and person B a loss of $15

  • Person A Closes the position at $1140 and makes $15
  • Person B Closes the position at $1140 and loses $15

That example makes CFDs look pretty simply, and that's because, well, they are.

Trading CFDs isn’t all that different from trading traditional shares;

  • If you buy 500 shares of a company at $5 then you have $2500 of stock.
  • If you buy 500 shares with a CFD at $5 then you also have $2500
  • If the share price rises by 10% then you have made $250 from your share trade.
  • If the share price rises by 10% then you have made $250 from your CFD trade

Advantages of CFD Trading

Profit and Loss Calculations

The Profit or Loss for a CFD can be calculated using a very simple formula;

P/L = (Sell Price* - Buy Price*) x No. of CFDs

*Without a decimal point

It doesn’t matter if you bought or sold first, the profit on a CFD is the difference between the buying and selling price.

Make profit from a falling market

With CFDs, you can benefit whether the price of an instrument is falling or rising. As we mentioned earlier there is no restriction on opening a position with a buy or a sell in CFD trading.

Entering a position with a buy-sell, which you would do if you thought the market was falling, is called short selling and allows you to sell a position first and then buy it back at a lower price.

Trade on a wide range of markets

With CFDs you are not limited to a specific asset class; you can trade all your favorites with CFDs. With Stockhome you can trade CFDs on:

  • Foreign Exchange (Forex or FX)
  • Commodities
  • Indices
  • Stocks
  • Cryptocurrencies

No Stamp Duty

Whenever you buy a share, you have to pay the government 0.5% of the value of your trade. Well not with CFDs; unlike other investments, there is no stamp duty to pay on a CFD trade.

Margin flexibility

CFDs are traded on what we call margin. This means that you can take a large position in the market without having to deposit the full contract value.

For example, Stockhome offers a leverage of 400:1 on FX meaning that you could leverage a $2,500 deposit to trade $1 million!

Leverage is a really efficient use of your capital and leaves your equity free to trade in various other transactions.

The potential risks of CFD Trading

CFDs can be a risky business; leverage allows you to take positions that are larger than your deposit size. It means you can potentially make large profits but also means that the risk of large losses is greater.

If you are a beginner then the most important thing is to manage your risk.

The 3 Main Market Categories

1.Bullion

2.Indices

3.Foreign Exchange

1.Bullion

Bullion is Gold and Silver and the demand for Bullion is driven by

1.their practical use

2.role as investments

3.store of value.

Paper currencies come with all sorts of problems, like the risk of being inflated in times of political and economic turmoil, and this can have a negative influence on their investments.

Gold and Silver are safer bets in this respect because their value doesn't rely on any particular government’s health and so issues like inflation and economic downturn don't really have as much of an effect.

When trading Bullion via a CFD, you don’t take delivery of Gold or Silver so the difference in the price between the buy and the selling price will be cash settled.

What are the Factors that influence bullion prices?

The price of Gold and Silver is driven by supply and demand, like pretty much all other investments and commodities,

it's changing in sentiment more than changes in production or jewelry demand that will affect the price because most of the Gold and Silver ever mined still exists and can therefore potentially come back on to the market.

Economic Factors

  • Low/Negative real interest rates: During times of low or negative real interest rates when significant inflation is present and interest rates are relatively low investors will seek the safe haven of bullion to protect their capital.
  • War: In times of great uncertainty, particularly when war is feared, the demands for bullion increases as investors see bullion as a solid investment which will always have a stable value in any country.
  • Sentiment: Whenever crises threatened the demand for physical bullion increases.

We quote bullion at 23:00 Sunday London time until 21:00 Friday London time.

We offer prices in Bullion 24 hours a day during this period apart from a daily exchange break at 22:00 – 23:00.

2.Indices

A stock market index is a listing of stocks and a statistic reflecting the combined value of its components.

All stocks in an index will have something in common, they’ll belong to the same industry for example, and the index is a tool to represent the characteristics of all these stocks.

There are also what is called specialized indices; these indices allow you to track the performance of a specific sector,

Most of the time, the indices that will be offered are the broader indices that cover the main stocks in the market.

A broad-based index represents the performance of a whole stock market and reflects investor sentiment on the state of the economy.

the most regularly quoted market indices are made up of the stocks of large companies listed on a nation's largest stock exchanges, such as the American Dow Jones Industrial Average and S&P 500 index, the British FTSE 100, the French CAC 40, the German DAX, the Japanese Nikkei 225 and the Hong Kong Hang Seng Index.

Factors that influence indices

An index will reflect the general health and stability of that country’s economy and will be affected by the countries industrial and political status. It is worth remembering that a country’s index is directly linked with the relative strength of that country’s currency; because it is its currency that will determine a company’s competitiveness on the international scene.

Industrial Factors

  • Relative Currency Strength: This will determine the competitiveness of a company to compete in the international arena. If the home country’s currency is strong then wages and production costs are going to be higher so to ensure a profit the cost of the end product is going to get higher too.
  • Trade Balance: This is the difference between the monetary value of exports and imports over a certain period of time. A positive balance is known as a trade surplus and means more goods have been exported than imported. The opposite is what we call a trade deficit. The key figure here is the export figure because an increase in this means either a strengthening competitive position at home and/or strengthening economies overseas are boosting the home country’s growth.
  • Industrial Production: Output for key industrial sectors such as manufacturing, mining, and utilities are highly sensitive to consumer demand and interest rates. This means Industrial Production is also key when forecasting economic performance and growth. In fact, it’s so important that it’s even used by central banks to measure inflation because high levels of industrial production can lead to uncontrolled levels of consumption which then leads to inflation.

Political factors are also very important. They’re interwoven with economic conditions for many investors when making investment decisions; and include things like the political and social stability in a country, government policies, regulatory environment, and central bank intervention.

3.Foreign Exchange

The Foreign Exchange market (also commonly referred to as the FX, Forex or currency markets) is the single largest market in the world with an average of approximately $5.0 trillion worth of currency traded every day.

The market exists wherever one currency is traded for another and consists of transactions between large banks, central banks, currency speculators, multinational corporations, governments and other financial markets and institutions. T

The FX market is an OTC (Over The Counter) market, in which participants trade via telephones and computer connections.

Stockhome received its pricing various reputable counterparty feeds. We do not physically deliver currencies, but offer them on a contract for difference basis, so that clients can speculate on the relative strength or weakness of a particular currency against another.

Factors that influence FX rates

Currency exchange rates are constantly changing and are influenced by the supply and demand for each currency.

The factors that affect supply and demand can be generalized into 2 groups: ‘

1.Economic

2.Political

Economic Factors

  • Purchasing Power Parity (PPP): This is a measure of what equivalent goods cost in two different currencies. If the EUR/USD exchange rate is 1.1200, and the same car in France costs €8,000 and in America costs $11,000, it would be cheaper for someone in the US to import the car from France (ignoring the cost of importing, tariffs etc.), as it would only cost €8,000 x 1.12 = $8,960. Therefore, the country with the lower domestic PPP will tend to weaken/depreciate as the consumers seek cheaper foreign goods and consequently exchange their domestic currency for the foreign one.
  • Relative Interest Rates: An Interest Rate is the return an investor can make by lending money in that currency. If an investor is able to receive an interest of only 2.5% in his domestic currency, but 5.8% in a foreign currency, that investor can increase his return by exchanging his money for the foreign currency and lending the money. The currency with the highest rates will tend to strengthen/appreciate as demand for it increases.
  • Economic conditions: If investors see opportunities to invest in a particular country, they will exchange their domestic currencies for the currency of that country, leading to the rise in the demand for the currency and hence the exchange rate. The components that make international investors view conditions as favorable are complex and multifaceted but include things such as GDP Growth, Inflation and taxation conditions.

Political Factors

Political factors are intertwined with economic conditions for many investors when making investment decisions; and include things like the political and social stability in a country, government policies, regulatory environment, and central bank intervention.

Opening Times

We begin quoting Foreign Exchange prices at 22:00 Sunday London time until 22:00 Friday London time. We offer prices in currencies 24 hours a day during this period.

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