What is CFD Trading - All about
What CFD Trading Really is
CFD (or Contracts for Difference) trading is a new way of trading the financial markets, which is based on market making. When a trader trades CFDs they trade contracts which change in value, mirroring exactly the change in price of the underlying market, which may be a stock, commodity or currency. Because it’s a leveraged instrument interest rate charges and credits apply, just like all leveraged financial instruments. In most countries, CFDs are regulated and income arising from CFD dealing is taxed under the capital gains tax regime, as if it were normal stock trading.
But there are some amazing advantages to using CFDs, over classic stock dealing, which many people don’t even know. CFDs are good, very good and efficient instruments to trade. This is because the CFD market provides superior liquidity, and superior liquidity means better filling price on every trade. In simple terms, CFDs are suitable for small retail traders, trading up to $100 per pip, or index point, or cent. Anyone trading under $100 per point is considered a small retail trader, and sure even $100 per point is a massive amount of money for 99% of retail traders. CFDs are not suitable for large, institutional traders, since these trade at sizes much larger than $100 per point, and the benefits of superior liquidity cannot be provided to these ultra large traders.
Liquidity in the markets is always provided from the large to the small, or from a large collection of small traders to few small traders. The CFD market facilitates amazingly good trading conditions for small retail traders, while it is also connected at some point to the open market and the big institutional traders. The thing is only small retail traders trading CFDs get all the benefits. That’s the advantage of being small.
All in all, CFDs are still little understood by traders in many countries, but those who do understand them are mostly wise traders, who specialize in few markets. And they trade CFDs very actively.
Think of CFD Trading Like a Harbor
You can think of CFD trading much like a harbor, where the sea water is connected to the water of the big oceans of the world, if you take 100 tons of sea water out of the harbor the open sea will instantly replace the loss. But the harbor protects the inner waters from outside waves, that’s the advantage of CFD trading, and only small retail traders can get them. The entire CFD market is rather unique in many ways, and it’s only available to small traders. But it does work, and that’s the important thing. And by knowing what to expect, traders can make the most out of it.
CFDs are so unique, that their superior liquidity not only means much better prices, but also the ability to trade stocks during rough times. When times are rough and the stock market falls fast, there may be short selling restrictions imposed, preventing stock traders from shorting stocks, and it has happened many times. And yet CFD traders are perfectly allowed to short the same stocks, that are under short selling restriction, and to profit from falling prices. This is another example of real life amazing advantage, unique to CFD contracts!
Just to give you an example, there were times where because of short selling restrictions you could not sell any stock listed on the NYSE. You stood to miss a lot of opportunity, for many days. CFD stock traders on the other hand profited enormously from short selling, as they were allowed by the nature of the CFD market to trade as normal. As a result, these were the biggest winners, they had an advantage that very few traders really had. The only other alternative was stock Options, by buying Put Options, this is how some institutional traders covered their risks. But these Put Options can get unbelievably expensive during volatile market times, much more expensive than CFDs are.
This is why CFDs are serious trading instruments and their benefits are hidden and not well understood. Traders need to take CFDs seriously, because they are intended for serious traders. These hidden advantages of CFDs would have saved many naïve investors and traders many $1000s if they knew how to hedge risk on their stock investments. And even now, many traders who have learned about CFDs, do use them in some sort of hedging strategy, as part of their investment portfolio. CFDs are powerful and simple at the same time. That’s why they are so important to investors and traders.
Commodity Trading Through CFD
CFDs are very good for commodity trading too, because in markets such as gold, crude oil, or agricultural commodities, traders look at complex patterns, involving both short term and long term predictions. CFDs allow them to get the best possible price for entering or exiting a trade, and at very good speed. This is because CFDs are very linearly priced instruments, as opposed to Futures or classic Options. Future contract prices can deviate significantly from the price of the underlying commodity, as they are not linear. Commodity Options, just like stock Options, they are good for various types of trades, but they are either too expensive to deal in, or cheap and non linear. So the typical at the money Option requires too much of market price movement just to reach the breakeven point. Whereas a CFD trade becomes profitable, from the first penny of movement, that the underlying commodity makes in your favor.
CFDs are superior for all kinds of commodity trading, and for all trades where high linearity is needed, so that the trade moves dollar for dollar with the underlying market. There are trades however where the commodity trader may choose to hedge part of the risk through classic Options, or through sophisticated binary options trading. Because CFDs provide all the linearity and liquidity one can get, while binary options provide non linear, probabilistically based payouts, for when things move fast and wrong. Which means it can work as an insurance on a trade gone bad.
Some traders have made millions of dollars trading very specific markets. There are traders who specialize in commodities such as sugar, or corn. Some of them come from a farming background and actually know all the secrets of production, what factors affect production of sugar and corn, and how prices will move. And of course they know that CFDs are the best way to trade these commodities. And even though these agricultural commodities may seem to have random and unpredictable prices, they are actually predictable by the specialists.
In the old days, large farmers themselves did trade futures, or agreed to contracts that worked like futures work today. But now trading has expanded to CFDs. And CFDs provide very linear trades that Futures cannot provide. And linear pricing means much more accurate trades.
Making Millions by Being a Specialist?
All good traders are specialists in one way or another, it has been proven that only specialists make millions. Traders who trade too many markets cannot possibly know all the secrets of these markets, like the sugar producer who knows all about sugar. So being a specialist in the underlying market is half the battle. The other half of the battle is being specialist in trading, more advanced trading, and hedging through binary options. Binary options, especially binary options types such as One Touch or No Touch are a great way to start exploring hedging possibilities on various markets, or any market that you understand best. In my opinion, commodity markets are the best markets to start trading, because supply and demand can actually be estimated, in fact, supply is rather limited, and demand is certain. In that regard stocks and some currencies are harder to predict. But commodities and commodity related currency pairs, such as USDCAD and AUDCAD are easier to predict.
If you wish to become a specialist in one commodity alone, such as gold or sugar, that is also possible. But it takes great passion and perseverance. In the case of gold, one has to understand how gold is mined and produced, the costs involved, and the uniqueness of this precious metal. In the case of sugar, again one has to understand the work involved in producing the actual product from the plants, and the risks involved.
As far as CFDs go, you only need to understand leverage and interest rate charges, CFDs offer up to very high leverage for commodities trading, but you don’t need more than 200 to 1. Interest rate charges do matter, but they are too small compared to the amount of money the trade will make or lose during a volatile trade.
I do believe that agricultural commodities are especially overlooked, because of traders’ mentality. They all want to trade what is fashionable, and typically only gold and stocks such as Apple are fashionable. But the big money can be made either in gold, through peculiar, non popular methods, or in agricultural commodities such as wheat, corn and sugar. In fact these overlooked commodities can make you more millions than any other market.
Moreover, commodities will become more and more important in tomorrow’s market, as demand will increase. And these specialist traders will have an enormous advantage. That’s why one can start learning about commodities and be sure that they will be on the right track to becoming a successful trader in the future. No other market is as safe to trade as commodities are, and if one cannot make millions in commodities, it’s unlikely they will ever make millions in any other market. That’s just the way it is. Because commodities provide the most possible information one can get about the future demand and supply, and these are the fundamental market forces.
CFD are a Win – Win Trading Tool
CFDs are amazing because of their unbelievable good liquidity and linearity, these are the biggest hidden benefits of CFDs! Most people think of CFDs as just another market trading tool, which offers high leverage and nothing more. Well high leverage is not big deal, many trading instruments offer high leverage, Futures offer it too. But CFDs offer perfect linearity that Futures don’t offer, and amazing liquidity that even the spot market itself doesn’t offer.
Linearity is important for making millions, because you cannot afford to close your profitable trades few dollars off the market price, it will cost you a fortune in the long run. And liquidity is just as important, because it will make sure that you will be getting the best possible price on every trade.
You can take things further by also trading stocks that are related to your chosen commodity. So if you trade gold, you can also trade selected gold mining stocks. Or if you trade sugar, you can also trade sugar producing stocks. The stocks in this case will always move in the direction of the commodity, always! And when I say stocks, I mean reputable stocks of well managed companies. By doing this trick in your trading, you will be able to get a huge discount on some trades, because there are many brief deviations in the market. Where for a little while a gold mining stock may have dropped in value, while the gold market remains very strong, that is an instant discount for you to buy that stock, through CFDs. And these deviations are even more profound in the agricultural commodities and their related stocks.
Realistically, it is possible to make a lot of money through such a strategy. I have seen a sugar trader who made $2million net profit, on sugar and sugar related stocks only. Though the exact starting trading capital was not known, it’s highly unlikely to be this successful if you trade any stocks, any popular markets that you don’t really understand. So being a specialist in your market is really important, and CFDs will make the goal even more realistic.