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Intro to CFDs

Find answers to the most popular questions regarding trading with OliveFX

CFD stands for Contract for Difference. It is an agreement between two parties to exchange the difference between the price the contract was opened and closed.

CFD trading lets you trade a range of popular financial markets without actually owning the asset. It allows traders to take advantage of price movements using margin.

CFDs have grown in popularity as a way for investors to trade actively in the financial markets. Some of the main reasons for this are outlined below:

Speculation

Traders can speculate on price movements across a vast range of markets

Long and short

Being able to go both ‘long’ and ‘short’ provides the ability to profit from both rising and falling markets respectively

Leverage

By using leverage traders can post a small percentage of the full trade value and take on a much larger position

Hedging

CFDs can act as a hedging tool for physical portfolios without having to liquidate assets to protect against market downturns

Flexibility

Smaller trade sizes compared with futures contracts and no contract expiry allow traders flexibility in the size of trades they make and how long they hold positions

CFDs are traded using ‘leverage’, which means you can use a small amount of money to trade a much bigger position. The terms leverage and margin are interchangeable as 100:1 leverage is the same as 1% margin or 400:1 leverage would equal a margin of 0.25%.

If you were buying 10 AUS200 contracts the notional value would be 10 multiplied by the current index price. Let’s say the AUS200 index is at 6,850 then the notional value of this trade would be A$68,500. If you have 200:1 leverage set on your account the margin required would be calculated by dividing the notional value by the leverage setting.

Margin required = (68,500 / 200) = A$342.50

Using leverage magnifies profits but also losses so make sure you understand this concept and manage your risk accordingly.

With OliveFX you can trade a range of different CFD markets with tight spreads and low margins, these include indices, metals, oil and other commodities.

INDICES

We offer CFDs on major global stock indices in the US, Asia, Europe and Australia. Stock indices are a basket of stocks and as they allow you to take a position across a wider market at a low cost are one of the most popular instruments to trade.

METALS

OliveFX offer CFDs on precious metals such as gold and silver with low trading costs and customisable leverage. Trading these markets using a CFD provides more flexibility than the futures market as minimum trade sizes are lower, and they do not expire.

OIL

You can trade US and UK crude oil markets using CFDs. The oil market is heavily driven by supply and demand along with geopolitical events. This means that prices can fluctuate significantly.

It is important to remember that margin and profits and losses are calculated in the market currency. If you trade the DAX for example, profits or losses will be calculated in Euros. OliveFX will automatically convert figures back to your account currency.

Index example

The trader, who has a USD account currency with 400:1 leverage, believes the Wall Street index will rise on the back of a positive upcoming economic announcement so buys 2 contracts with the index trading at 25,012

Margin required = (25,012 x 2) / 400 = $125.06

The news is positive, and the index rises. The trader closes the trade at 25,125. This is 113 points above the entry price

Profit = (25,125 – 25,012) x 2 = $226

Gold example

The trader has an AUD account currency with 200:1 leverage and buys 1 gold contract (XAU/USD) at 1285.20

Gold contracts are 100 ounces each (you can trade as low as 0.01 contracts effectively making it equivalent to 1 ounce). When trading metals, tick values are calculated by multiplying the number of decimals by the number of ounces

Margin required = (1285.20 x 100) / 200 = $642.60 which would be converted to A$892.50 assuming AUD/USD is trading at 0.7200

Gold rises due to safe-haven demand and hits the trader’s take profit order at 1300.00

Profit = (1300.00 - 1285.20) x 100 = $1,480

Convert to AUD at 0.7200 = A$2,055.26

Oil example

The trader has USD as their account currency with 100:1 leverage and sells 5 WTI (USO/USD) contracts at 57.120

Oil contracts are 100 barrels each (you can trade as low as 0.01 contracts effectively making it equivalent to 1 barrel).

Margin required = (57.120 * 50) / 100 = $285.60

Oil rises due to supply concerns and hits the trader’s stop loss order at 58.500

Loss = (58.500 - 57.120) x 500 = $690

Given CFDs are traded on leverage it is imperative you are aware of the risks associated. The keys to managing this risk are using stop loss and take profit orders and not over-leveraging yourself.

Using stop loss orders effectively will reduce the risk on each trade to a level that is fine for you to accept. If you only want to risk $100 on a trade take a position size relevant to this depending on where you want to place your stop loss order.

For example, when placing a long trade, you accept US30 may drop by 100 pips to a support level then buy 1 CFD where each point is worth $1. Similarly, if you want to make double the amount you are willing to risk you should place a take profit order 200 points above the market.

It is always worth keeping in mind the risk to reward ratio. By aiming to make more than you are willing to risk you can get half your trades correct and be in profit overall. A risk to reward ratio of 1:2 or 1:3 is common with successful traders.

Leverage is also a key factor in managing risk. It is important you monitor the margin level on your account so that it doesn’t fall too low where you may receive a margin call or stop out. Over-leveraging means taking on too big a position for the size of your account and can quickly deplete your trading account if the trade goes against you. Remember leverage magnifies both profits and losses so needs to be managed effectively.