How to do Equity Trading With CFDs (With Examples)
You can trade in the markets in several ways. CFD (contracts-for-difference) are a popular way to trade on commodities on the market. It is one of the ways to diversify your portfolio and reduce the risk. By trading in CFDs, you purchase a specific number of contracts on a market where you expect the price to rise and sell them if you anticipate a price fall. You earn profit from the price movements of commodities. However, you should not be fooled into thinking that trading CFDs is just about buying and selling in the anticipation of a price rise or fall.
Trading in CFDs is more complicated than that especially because a lot depends on the platforms you use and their functionality. As it varies from provider to provider you must understand it better before you start trading equity with CFDs. Let’s see how it can be done.
Steps to start CFD trading
You can start CFD trading in these steps:
- Learn how CFDs work
- Create and add funds to your account
- Build a trading plan
- Find a trading opportunity
- Choose the trading platform
- Open, manage and close your first position
Learn how CFDs work
Before you start trading you must learn how the CFDs work. There are several differences between CFDs and other forms of trading. You must understand the differences if you wish to trade effectively.
Create and add funds to your account
Once you understand the nuances of the working of CFDs, the next step is to apply for a CFD trading account. Opening a CFD trading account is rather easy and generally takes no more than a few minutes. After opening the account and verification of the account, you will have to fund the account. Funds can be added to the account via credit or debit card. It is a good idea to open a demo account and practice trading before you trade on the market.
Build a trading plan
After adding funds to your account, the next step is to develop a trading plan which contains a thorough blueprint for your trading activity. The blueprint should contain details such as your motivation, goals, risk aptitude, available capital, time commitment, markets to trade, and preferred strategies. The trading plan should help you make better decisions even under pressure situations as it defines your ideal trade opportunities, desired profits, risk management strategies, and so on.
Find a trading opportunity
Once you’ve opened and funded your trading account, the next step is to find your first trade. There are several options such as shares, indices, forex, cryptocurrencies, and commodities to trade on. Unless you are clear about your trading options, it can be a daunting task choosing which market to trade on. You’ll find it best to start somewhere like stocks or commodities before expanding to other options.
Choose the CFD trading platform
You must choose a trading platform to trade on the markets. There are different kinds of trading platforms such as:
- Web-based trading platform
- Mobile trading apps
- MetaTrader 4
- Advanced platforms
All these can be customised to suit your trading style and choices, along with features such as personalised alerts, interactive charts, and risk management tools, to name a few.
Open, manage and close your first position
Now that you have decided which market to trade on, it is time to place your first deal. You must decide whether you want to go long or short. So, if you are trading the FTSE 100 and feel that the value will fall, you must go short (sell). On the other hand, if you are convinced the value will rise, you should go long (buy). The major advantage of CFD trading is that you have the option to do either.
Once you take a position (long or short), your profit or loss moves in line with the main market price. You can monitor your open positions, and close them by hitting the close button on the trading platform. Conversely, you can do it manually by placing the same trade in the opposite direction if you don’t force open the new position. So, if you opened a position by buying, you can close it by selling the same quantity of contracts at the selling price and vice versa.
The profit or loss is the sum of the amount the market moved and the size of your trade-in dollars per point.
Points to remember while placing a trade
Bid and offer prices
You’ll always be offered two prices based on the value of the instrument you trade - the bid (buy) price and the offer (sell) price. The bid price will always be higher than the present value and the offer price will always be lower. The difference between the two is called the spread. CFD trades will be charged via the spread, except in the case of shares where it is in the form of commission.
Number of contracts
While trading CFDs, you must decide on the number of contracts you want to trade. Every market has its own minimum number of contracts. For instance, in the case of the FTSE 100’s, it is one contract. Here, one contract equals $10 per point. It means that you’ll gain or lose $10 for every point of movement in the index value.
Remember that CFDs are leveraged products. It means you’ll need to put down only a small deposit to gain access to the full value of the trade. Although it can take your capital further, it will also lead to losses higher than your initial outlay.
Stops and limits
Adding a stop is one of the ways to restrict your potential losses. When you add a stop, it automatically closes your position if the market moves against you by a specific amount. There are different types of stops such as:
Basic – It closes you out as near as possible to the price level you choose.
Guaranteed – This closes you out at the level you asked for, regardless of the market gaps.
Trailing – It moves with your position as the market moves in your favor, and locks in when the market moves against you
Limits, on the other hand, closes your position while the market moves a specified distance in your favor. Limits offer a great way to earn profits in volatile markets.
CFD trading examples
For a novice, CFD trades would seem more confusing than traditional trades. Here are some examples to help you understand it better and guide you around opening and closing positions.
Buying a share CFD
C has a sell price of $25.99 and a buy price of $26.00
The fourth-quarter earnings announcement of the company is due. Based on your research and information, you expect it to be good news. You assume the share price will go up once the announcement is made and so you buy 1000 share CFDs at $26.00. This is the same as buying 1000 shares of C.
As CFD trading is a leveraged product, you need not put up the full value of these shares upfront. You only need to cover the margin, which is the sum of your exposure and the margin factor for the market you are trading.
In our example, if C has a margin of 5%, then your margin would be 5% of your trade’s total exposure, which will be $1300 (1000 x $26= $26,000 and 5% of 26000=1300)
If your prediction is correct, the share price will increase, and if you decide to close your position when the prices reach $30.00 with a buy price of £30.01 and a sell price of $30.00. To close a position, you reverse your trade. So, you’ll sell your 1000 CFDs at $30.00
To calculate your profit, you just multiply the difference between the closing price and the opening price of your position by its size. $30.00 – $26.00 = $4, which you multiply by 1000 CFDs to get a profit of $4000.
You will have to pay a commission fee and overnight funding charges, if any, from the profit you earned.
If your prediction is wrong and C’s results are worse than you expected, the share price will fall immediately. You can decide to cut your losses and sell your 1000 CFDs at $28.00. As you can see your position has moved $2 against you, leading to a loss of $2000 (plus commission and overnight charges).
Thus, you can use CFDs to trade profitably in equity. You can use hedging to minimise losses and to ensure profitability. All in all, CFDs are a great way to trade in equities and other options on various markets. As all markets are available on a single platform, switching from indices to energies or equities is as effortless as a couple of clicks.
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