Interested in trading CFDs?

The contract for differences, otherwise known as CFDs, are a favorite investment option for private investors, like you. They entered the market of retail financing in 1998. That was ten years after investors recognized they could replace traditional share markets.

At the time, the high stamp duties created by the UK Government contributed to CFD's rapid growth. Maintaining short-term positions in the traditional market was a problem. It led investors to throw their money behind CFDs.

Unlike other strategies, CFDs are excellent for short-term positions in markets. Both then and now. When you're ready to learn how to capitalize on this new trading strategy, grab a cup of tea, cozy in, and read on.

Defining CFDs

For those of you who've never heard of these types of trades, we'll give you a brief introduction to CFDs.

In essence, contract for differences are a way for traders to profit from price movements. The best part? Traders don't actually have to own any of the underlying assets.

The difference between the price as you enter a trade and the price as you exit a trade determines your profit or loss.

CFDs are simple securities, computed by your asset's movement between your trade entry and exit. This calculation is performed without consideration of the asset's underlying value.

CDFs are also leveraged. That means you gain large market exposure for a small initial deposit. Said in a different way, the return on your investment is much larger than in other, similar forms of trading.

Keep in mind that while greater leverage can magnify profits, it can also magnify losses. If prices move against you, it's possible to close out of your position by a market call. In this case, you could also top up your funds to keep as an alternative, to keep your position open.

Note: If you're in the market for more than one type of investment strategy, take a few minutes to learn about short selling. It has a moderate learning curve, but it's one of the best methods to make money fast.

Trading CFDs

If you're trying to learn how to trade CFDs, the following steps will give you a brief overview of how it's done:

Determine your financial instrument: What will you choose to trade on? EUR/USD? UK 100? You can use CFDs across a wide range of markets, like forex, indices, shares, commodities, or treasuries.

Decide to buy or sell: Go long (or buy) when you think prices will rise. Go short (or sell) when you think prices will decrease.

Choose a trade size: How many units would you like to trade? The value of each CFD unit varies. Its value is dependent on which instrument you've chosen to trade.

Manage risk: Choose from a range of stop-loss orders. Those include "guaranteed stop-loss orders," otherwise known as GSLOs. Sure, GSLOs come at a premium, but they're well worth the money in some cases.

They guarantee you close out of a trade at your specified price, regardless of gapping or market volatility. If the GSLO isn't triggered, it's refunded in full.

Monitor position: After you place your trade, monitor your open positions, so you can follow your real-time profit or loss. That includes any take-profit or stop orders. Never forget, your losses can exceed your deposits.

Close position: If a take-profit or stop order doesn't trigger your trade to close out, you'll have to close out your trade manually.

Markets You Can Trade CFDs

The following are the common global markets on which you can trade CFDs, both short and long:

• Commodities
• Currencies
• Shares
• Indices
• FX

If you don't see your market here, check again in the future. There's a chance more will be included.

CFD Examples

For those of you who are new to CFD stock trading, don't worry. This article is the "CFD for dummies" version. Let's look at some examples.

Let's assume for the sake of argument that Acme plc is trading at 1599/1600p. You think the price will rise, so you decide to buy 1000 share CFDs (units). Acme plc has the tier one margin rate of 5%.

That means you deposit 5% of Acme plc's position value as position margin.

Your position margin is going to be £800 (5% margin x (1000 units x 1600p purchase price)). Don't forget, if the price moves against you, it's possible for you to lose more than £800.

Possible Result A of Your Trade: You predicted correctly. The price of Acme plc rises in the next hour to 1625/1626p. You sell at the new price, 1625p, and close your position.

The price moved 25 pence (1625p - 1600p = 25p) in your favor. To calculate your profit, multiply 25p by your position (aka 1000 units). It leaves you with a profit of £250.

Possible Result B of Your Trade: You predicted incorrectly. The price of Acme plc plunges over the next half hour to 1349/1250p. You're certain it will continue dropping, and you want to bail out as soon as possible. You want to limit your losses, so you sell at 1349p. That closes your position.

Here are the calculations. The price moved 250p (1350p - 1600p = -250p) against you. To calculate your loss, multiply 250p by your position (1000 units). You come up with a loss of £2500.

Other Things to Consider

Commission costs for CFDs run at 0.10% with a £9 minimum commission charge for each trade. The costs can dramatically influence your bottom line if you're only performing small trades.

You also need to consider holding costs. You'll be charged a holding cost for any position you hold after 5 pm PST. This price is automatically built into the price of products with fixed expiry.

What's next?

Trading CFDs is a relatively easy game to understand, though a difficult game to master. If your interested in learning more, try trading paper or creating a demo account. Then you can get a better feel for how the game is played without risking any actual money.

Are you curious to learn more? Then drop what you're doing and come take a look at our list of epic finance articles.

So long and good luck!