There are many tools to help traders determine whether they should buy or sell given security in the financial trading world. One crucial tool is CFDs, also known as Contracts for Difference.
CFDs (Contracts for Difference) are derivatives that allow you to trade an asset without actually owning it, but despite that, they provide exposure to the underlying asset’s price movements. In other words, you can go long or short without buying a stock, which makes them a very flexible trading tool.
Ownership of a CFD represents an agreement between two parties to exchange the difference in the value of assets between now and the contract’s expiration. It differs from futures contracts where both sides have to buy and sell simultaneously as each other. In addition, CFDs allow traders to leverage their capital by allowing the trader to use only margin as collateral instead of cash to hold a position.
Therefore, it is possible for traders with small amounts of available capital interested in going long or short on particular securities.
Use CFDs to diversify your portfolio
CFDs provide exposure to underlying security without going long or short, so they are beneficial for traders who want to have a more balanced, less risky trading account. By using CFDs instead of margin loans, you can buy and sell CFD contracts with cash rather than with margin loans which means your losses will be limited only by the value of the cash you invest into them.
You can also use CFDs as a hedge against stock market volatility because if your shares drop in value, your CFD position will increase in value, thus balancing out some of your losses. Also, it is possible to spread risk between different commodities using just one product by simultaneously purchasing many different types of commodity CFDs.
Start with a demo account to learn how CFDs work
It can be instantaneous to lose large amounts of money if you don’t know what you are doing when CFD trading in Australia because they have so many risks involved. Therefore, it is a good idea to practice using a demo account that will allow you to take part in virtual trading without risking any of your own money before you start trading with real money.
Trading on the stock market involves risks, including investment loss and financial losses, so new traders must understand this entirely before beginning their trading career.
Only use 1-5% capital for each trade
As we mentioned above, CFDs enable traders to invest with less capital than they would open a position with, for example, the share market. The minimum amount is relatively low – as little as $100 – but if you have your heart set on trading CFDs, there are some golden rules that you should keep in mind before making any trades.
Only use 1-5% of capital per trade and ensure that you never exceed your account’s margin limit. If you do not stick to it, it is elementary to lose money very quickly because, for every pip movement in the value of the contract, 10% of the initial margin is required, resulting in quick and significant losses.
Avoid using leverage
Even though we mentioned its benefits above, using leverage will make it much easier to lose money, especially if you are a novice trader, because it amplifies the risks involved. This is why CFDs should be used by experienced traders only who know how to handle the risks calmly and avoid any wild price swings that might cause them to lose their entire investment.
What risks are involved with trading CFDs?
Trading CFDs involves many risks, including the risk of losing more than your initial investment. That is why you should only use 1-5% of your available funds per trade, never exceed your account’s margin limit and avoid using leverage because it amplifies the risks involved with trading CFDs.
The difference in value between a buyer and a seller represents the profit or loss made by the transaction, so when trading CFDs, this will be multiplied tenfold for every pip movement in price. It can result in significant losses quickly if you are not careful with how much you invest in each contract. Novice traders must be aware of these risks before trading in Australia’s financial markets.