How to Trade CFD and Spot Forex

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How to Trade CFDs and Spot Forex

Why Some Wise Traders Use CFD

Traders who use CFD (Contract for Difference) contracts tend to trade both currencies and stocks, and even some commodities from time to time. A CFD broker allows them to do it all through a single account. They prefer CFD stock trading over actual stock trading, because transaction costs are lower, and liquidity is much better at all times, and remains good for trading up to the size of $100 per dollar cent, or pip, or whatever the minimum price increment is in the underlying stock or other market. CFDs are made for small retail traders, but as you can imagine this limit of $100 per index point or pip, is still large enough even for very serious traders.

Moreover, the CFD market provides a more linear pricing, as opposed to other alternatives, such as Futures or classic Options. The way CFD work is very simple and straightforward, so that all beginner traders can handle. And in principle, and in terms of costs and charges, it works similar to the spot forex market.

So someone who trades currency pairs, can do it all through a good forex broker. But if they also want to trade some commodity such as gold or crude oil, which impacts a specific currency pair, then the spot forex broker may or may not have such markets available. Some forex brokers offer gold and crude oil trading, but not much else. Moreover, the same trader may also want to trade few stocks related to a commodity, and also trade the currency pair which is most affected by that commodity. For example gold price affects the AUDUSD currency pair, and it also affects all gold mining stocks. So a trader who wants to trade all these markets impacted by gold, will have to use a single CFD account.

Gold is one commodity that impacts AUDUSD, not all the time, but for most of the time, it also impacts all gold mining stocks. So you cannot afford to trade gold mining stocks or AUDUSD and ignore the price of gold, because if you go against gold’s trend your trade will end up losing, sooner or later. An even stronger correlation exists between crude oil and USDCAD, but in an inverse way, a negative correlation that is. While all oil stocks are positively correlated to crude oil. USDCAD is inversely correlated because the Canadian dollar is positively correlated to crude oil, and that’s because Canada is a large crude oil exporter, just like Australia is a large gold exporter. That’s how commodities, stocks and forex, all impact one another. Here the rule is that the bigger market will affect the smaller related market. Commodities affect everything else, currencies affect commodities to a lesser extent, while stocks cannot affect commodities. Stocks however may lag behind the related commodity, for example a gold mining stock may lag behind gold price, for a while, thereby offering a huge discount. Because that stock will have more room to move higher up, than gold will have, in the next up trend. That’s how traders think.

How Wise Older Traders Use CFD

Many trading veterans use CFDs today, to trade the markets, because they will do things such as hedge downside risk on a stock that they already own. Or they may use CFD specifically, in synthetic trades where 4 or more CFD trades are used, and CFDs allow them to do it all fast, efficiently, and at lower dealing costs. In extreme cases, when the US stock market drops too much the securities and exchange commission in the United States may temporarily prohibit the short selling of stocks, to limit further downside movement. In such cases all stock and futures traders cannot longer short US stocks, whereas CFD traders are not affected and can continue to short these stocks. This may not sound so necessary, but these restrictions do happen when the US stock market drops too much, and it usually happens at least once every 10 years, and it lasts for many weeks, beginners should be aware of this. Because if you get caught in such a short selling ban and you are unable to go short a stock, you won’t be able to trade your stock strategy.

Trading veterans also use CFD to enhance forex trading. If a forex strategy requires trading several currency pairs, interest rate charges and liquidity become important. A CFD broker may offer the lowest charges for one currency pair, while a spot forex broker may offer the lowest charges and margin requirements for another pair. In general, the higher the margin requirement of a broker is, the lower the interest rate charges are. So one broker may require a $3,000 margin for a given trade, and charge very high interest rate. While another broker may require almost 10 times bigger margin, but they charge no interest at all. That’s the tradeoff between margin requirements and interest rate charges. There’s no one size fits all broker to use for all strategies. Wise traders have found that complex strategies, require using 2-3 different brokers. Even in forex, sophisticated strategies require you to use 2-3 different brokers, both CFD and spot type. And place your trades so that minimal margin is used, and the lowest interest rate charges are incurred. Interest rate charges are only relevant for trades lasting several days or more, and the higher the leverage used, the higher the charges are. For very short term trading, such as scalping or day trading you can still do all your trades through a single broker.

There’s no limit in how wise traders can think of improving their strategy, lower costs and remove a lot of market risk, it’s all about basic proven facts seen in forex and commodities. Today CFDs are used by both beginners and veteran traders, for achieving just that.

What Beginners Need to Watch Most

Traders of all levels, but especially beginners, need to ignore some old classic tips which are no longer relevant in today’s markets, or tips that were wrong all along. Deep down, if your strategy is based around some good tips, you will avoid making the mistakes that 1000s of other traders make. First of all, you have to forget the notion that the market is always right, because it isn’t! If the market was always right, I’d be so super liquid and efficient, that no volatility would exist, and prices would be going nowhere. But that’s not what you see, volatility does exist, and prices do move a lot, and in many mysterious ways. As if the market cannot make its mind up, in other words, the market isn’t always right, and especially on an intraday basis, where deviation from right price can be huge, and can last for hours.

Pay attention to the daily chart, ignore all news, and focus on solid indicators and analysis methods. One useful tool that the spot forex market has, are the variable spreads. All ECN type spot forex brokers have variable spreads, by watching these spreads you can tell if there is little or much liquidity in the market. Most currency pairs tend to have their spreads widening when volatility increases, which means less liquidity, and higher probability for the market to move up or down, to a specific intraday level. This is only possible to monitor, through ECN spot forex brokers. You can do your forex trading from any type of broker you choose, ECN type, STP type, MM type, or CFD type broker. In most cases a CFD type broker will work just fine. For larger size, fast trading, an ECN type broker will work best, for slow trading STP or MM type brokers work just as good and will have lower costs. But in general, you can start trading today, doing all trades through a CFD account, and just use an ECN account to monitor the widening of spreads, which is an intraday volatility indicator. With more experience you will be able to confirm intraday moves, using the widening of spreads alone.

By the same token, there are traders who never trade stock options, never, not once. But they do use stock options as indicators, because some types of stocks are possible to predict through the way that their option premiums change. All this information comes from option premiums, but the traders trade these stocks through a CFD account. CFD are perfect, they provide liquidity, safety, linearity, efficiency, low cost trading, but they don’t offer the inside information which some wise traders get out of studying the fluctuation of stock option premiums. This is one of the extremely rare methods, and the closest you can get to legal inside trading. There’s nothing illegal. But the information about a stock moving higher, is so secret, only lawyers and CEOs know about it, but also option brokers know about it, and whole deal is subtly reflected in the premiums. Most wise traders don’t actually trade classic stock options, because unlike CFDs, they are inefficient or too costly, they simply spy on them.

So it’s important to know how one financial instrument differs from another, and even if not using it to trade, use it as an indicator. Beginners should plan their forex trading according to their budget, margin requirements and interest rate charges. Both CFD and spot forex brokers can facilitate forex trading, CFDs are slightly better for beginners, since they keep things simple. But you will need CFDs later on, even in sophisticated trades, where both CFD and ECN brokers may be needed. Above all, a CFD trading account will allow you as a beginner to see many different markets, currencies, stocks and many commodities, and this will help come up with new strategies. Jumping directly into an ECN forex account will only offer you forex and maybe 2-3 commodities. So in that regard, trading CFD is better also.

Learn from Veteran Traders

Beginners can learn more from veteran traders, than they can ever learn from all books and seminars combined. The problem is that veterans hardly ever share their secrets, they will only tell you bits and pieces about their methods, and nothing more. You should be careful who you take trading advice from, some veterans are very profitable, but still believe in some false trading tips, tips that will not help you in any way.

Trading veterans tend to be specialists, and trade forex through fundamental analysis. Yet their fundamental analysis is hard to understand and use. I have found that all trading tips that seem simple and easy to use, in practice become ambiguous and difficult to apply. I can watch the variable spreads of an ECN forex broker, to assess my CFD trade on EURUSD, and whether it will have momentum or not. But I cannot use poor tips such as ‘cut your losses short and let your profits run’ it sounds ridiculous and it amounts to no tip at all. What is a loss, and what is a profit? Nobody can really tell right away. That’s why I only listen to veteran traders who know what they are doing with their trading.

Veteran traders gained their experience trading tough spot markets, the spot forex market being one of them. And they learned many things, and at very high cost. The CFD market today doesn’t offer great insights into market price action, but is so much more affordable and liquid, that it makes sense to start all trading strategies with CFDs only, before expanding to other instruments at all. With that, I can say that I would prefer taking trading advice from such trading veterans, who come from a spot forex market background, rather than a CFD veteran. But for my own trading, I would rather use a CFD trading account to actually trade, for the most part this covers all my trading needs. As I mentioned, one can still expand their trading methods, and use both spot forex and CFD brokers later on. But for exploring the markets first time, and start testing different trade ideas, a good CFD broker can offer you almost all you will ever need.