Introduction to CFDs
If you are looking to trade Commodities or Stock Indexes such as Gold, Oil, the Dow Jones, or FTSE, then CFDs are for you.
CFDs stand for Contracts For Difference.
When you trade a CFD, you enter a Contract with your broker on based on the change of price of the underlying asset.
For example, Crude Oil CFDs track the price of the most current Oil Futures. If the Oil Futures are currently trading at $50/barrel, you will see the CFD traded at a similar price. Therefore, if you buy the CFD when the price of Oil is $50 and it rises to $55, you will gain $5 on the CFD, just like if you had bought the actual Futures contract.
But, unlike regular futures, CFDs are available for much smaller purchase sizes and greater leverage. This makes CFDs an ideal product for investors that are looking to trade in the Commodity and Stock Index markets.
Why Trade CFDs?
A great benefit of CFDs is that they can be traded in small sizes. Also, like Forex instruments, large leverage is available for CFD trading. This compares to Futures contracts which are available only in large contract sizes and require a hefty minimum margin requirement per position.
For example – a futures contract on the S&P 500 is based on 50 times the value of the S&P 500 Index. Therefore, if the S&P 500 is trading at $1000, the value of the futures contract is $50,000, and each change of 1 point in the index lead to a $50 gain/loss in a futures position. Also, to hold that $50,000 position, you will need to have an initial margin requirement in your account of $5000.
With CFDs, SMI Markets allows you to trade position sizes of just 5 times the value of the S&P 500. Therefore, the minimum position size in our example would only be $5000 (this compares to $50,000 above). Also, SMI Markets has an initial margin requirement of only 2% of the contract size. Therefore, even if a CFD trader would take a $50,000 position like the real Futures contract, the minimum margin would only be $1000.
How to Trade CFDs
CFDs are bought and sold like any other trading instrument. Therefore, if you believe prices of Crude Oil are going to rise then you would buy the Crude Oil CFD. You would then close the position by selling the CFD. Your profit or loss would be the change in price of the CFD between the time you entered and closed the position.
Since CFDs are based on Commodity and Stock Index prices, traders use either technical and fundamental analysis to determine whether prices will rise or fall.
For example, if a large storm is coming which could knock out Oil supplies, a trader could buy the Crude Oil CFD on the belief that a decrease in oil supplies will raise the price of Oil. Also, if a trader believes that stocks have risen too much and are overbought, he/she could Sell a Stock Index CFD to profit on any drop in equity prices