Introduction : CFDs Trading
What are CFDs?
Contracts for differences (CFDs) are derivative instruments. CFDs normally take place in various assets, such as commodities, forex, or shares. Traders speculate on the price movements of the given assets. There are positions traders load on these assets in the direction of long or short, speculating on the direction in which the assets will probably head and based on which they make profits or incur losses. Traders basically own the CFD contracts, unlike owning the underlying assets or trading on them.
A long position is when a trader expects the underlying asset to increase in value, and a short position is when someone expects the underlying price to go down. In case the speculations go correct, traders really make value, but if they go against the motion, traders really incur losses.
The most common form of CFD trading in Australia is in ‘currencies’ and ‘commodities’ such as iron ore, oil, gold, and wheat.
What are the advantages and disadvantages of CFD trading?
Here are the following advantages to CFD trading:
• High return-generating ability: CFDs are leveraged financial instruments; small traders may have the chance to make fortunes out of smaller investments than you make in share trading.
• Protection against loss. If a trader expects that share prices are going to fall in the future, he will be able to offset losses to the value of his portfolio through CFDs instead of selling the shares.
• Market access: CFDs have greater accessibility to various financial instruments and global markets.
• Profit from losses: By going long or short, a trader can benefit from both rising and falling stock and commodity prices.
• No expiry date: generally, CFDs have no expiration date, like futures trading.
Other than the advantages, CFDs also have demerits, as follows:
• High potential losses: CFDs are leveraged; in case the speculations go wrong, the loss could be greater than the real capital invested.
• CFDs are a bit complex. The complicated nature of CFDs means that only advanced traders should participate in the market.
• Volatility risk: Due to the quick price movements in the market, you could be winning one minute and losing the very next.
What are the types of CFDs in Australia?
In Australia, there are three different paths to accessing CFDs, as follows:
• Direct market access (DMA)
• Market maker
• Exchange-traded
Market makers and DMAs are the most common methods by which traders practice trading in Australia and internationally, whereas exchange-traded CFDs are generally traded on the Australian securities exchange. Let’s understand these types in a more elaborate form:
• Direct market access (DMA) is basically a trade that is executed through an electronic platform supported by a broker to access liquidity to trade securities to buy or sell. Generally, this can be a broker or dealer holding a specific number of stocks of a particular security in order to facilitate trading in that security. By using a DMA, the investor can manage its account and trade directly without the intermediation of brokers and dealers, which mean the trader, can have access to the infrastructure of the sell-side firms with significantly lower costs and expenses.
• A market maker is basically a trading company that creates its own market and determines the price range for the underlying asset on which the CFDs may be traded. It creates both the buy and sells prices for a financial instrument or a commodity. This is defined like this: if a trader buys a CFD over a particular asset, he is a price taker, not a maker. However, the prices do not differentiate much from the market price of the underlying asset, which means that a trader needs to deal through a broker or dealer and does not have access directly to the market, as in the case of a DMA.
• Exchange-traded CFDs: Exchange-traded CFDs are basically listed on the ASX and mainly traded through brokers. The ASX has mandated various norms and conditions in order to minimize risks, as it is a differentiated market.
Frequently Asked Questions (F.A.Q)
What is a CFD trading?
CFDs are basically derivative instruments. Traders speculate on the price movements of these CFDs. Traders load positions in the direction of long or short, speculating on the direction in which the assets will probably head and based on which they make profits or incur losses. CFDs normally take place in various assets, such as commodities, forex, or shares.
Is CFD trading legal in Australia?
CFD trading is legal in Australia and traders may reliably trade with the support of an authorized person (regulated brokerage platform).
Is CFD trading well for beginners?
Traders should have the willingness and courage to take risks to manage trading in CFDs, as it provides an opportunity even for small traders with smaller capital to have a turnaround profit, but it also carries a lot of risk.
Do you pay tax on CFD profits in Australia?
CFDs are effectively financial products that are input taxed under the legislation in Australia.
What is the difference between CFDs and futures?
CFDs and futures are both leveraged financial derivative instruments. However, there is some difference, as follows:
There is no expiration date in CFDs, futures have one. The capital requirement in CFDs is less, so even smaller traders may take a chance, while in futures trading, though leveraged; it requires higher capital for trading.
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