10 CFD Terms You Need to Know

Interested in CFD trading? A CFD is an agreement to exchange the difference in the value of an asset from the time the contract is opened until the time at which it's closed. With a CFD you never actually own the asset or instrument you have chosen to trade, but you can still benefit if the market moves in your favor, or make a loss should the market move against you. Let’s take a look at 10 terms you need to know as a beginner!

1. Contract for Difference (CFD)
   A CFD is a financial derivative that allows traders to speculate on the price movement of an asset without owning the underlying asset. When trading CFDs, you agree to exchange the difference in the price of an asset from the time the contract is opened to the time it is closed.
2. Leverage
   Leverage enables traders to amplify the potential returns on their investment by using borrowed funds. In CFD trading, leverage ratios can vary depending on the asset class and the broker, but they typically range from 10:1 to 30:1 or even higher.
3. Margin
   Margin is the amount of money or collateral that must be deposited by a trader with their broker in order to open and maintain a trading position. It is typically a fraction of the total value of the position being traded, known as the margin requirement.
4. Spread
   The spread is the difference between the bid (ask) and ask (bid) price of an asset. The spread is essentially the cost of executing a trade and represents the broker's profit. It is typically quoted in pips (for forex) or points (for other assets) and can vary depending on market conditions, liquidity, and the broker's pricing model.
5. Hedging
   Hedging is the action of reducing the risk of an outright position in one market, by taking an opposite position in a similar, or derivative market. Hedging mode enables the opening of multiple positions with the same instrument. Each position is executed independently at the prevailing market price upon opening. To adjust the size of any particular position, you can select it and place a market order to decrease its quantity as needed.
6. Ask price
   The ask price is the specified price at which you can purchase CFDs. It is always the higher of the two prices quoted and is called the ask or the ask price. The ask price, usually referred to as the 'ask', is defined as the minimum price a seller is willing to accept for the instrument.
7. Bid price
   The bid price is the price at which you can sell CFDs. It is always the lower of the two prices quoted and is called the bid or the bid price. The bid price is normally higher than the current price of the instrument, while the ask price is usually lower than the current price.
8. Closing price
   The closing price refers to the value of the CFD transaction as determined by brokers based on current and anticipated market conditions.
9. Pips
   A pip stands for ‘percentage in points’. A pip is the smallest price change that a market can make. Pip size changes across most markets. The value of a pip depends on the CFD product that you are trading, the currency your account is denominated in, and the size of your trade.
10. Stop loss
    A stop loss is an order used to specify a predetermined price level in the market. If the market reaches this level, the trade is automatically closed out by our systems, usually resulting in a loss. The term "Stop Loss" originates from its function of halting or limiting potential losses in trading positions.

In advanced trading methods like CFDs, several crucial technical terms convey essential information in a concise and specific manner. Now that we've explored several key terms specific to CFDs, you're progressing toward a more comprehensive understanding of CFD trading.

Is CFD trading good for beginners?

While CFD trading can be attractive due to its low initial capital requirements and potential for high returns, it's important to acknowledge the associated high risks.

Before entering this asset class, novice traders should exercise caution and ensure they have a solid understanding of the market. Implementing risk management strategies, such as limiting leverage and using stop-loss orders, is essential for managing these risks effectively.

If you’re eager to explore CFD trading, here are a few important points to keep in mind.
Regulatory Considerations. In some countries, such as Singapore mentioned earlier, CFDs are classified as Specified Investment Products (SIP), requiring a Customer Knowledge Assessment (CKA) before trading. Ensure you understand and comply with local regulations.

• Risk and Leverage
  CFDs are leveraged products, which means trading on margin can magnify both your potential profits and losses. It’s crucial to approach this aspect with caution.
  
• Market Knowledge
  Successful CFD trading requires a good understanding of the underlying assets and markets you intend to trade. Conduct thorough research and stay updated with market trends. Conduct thorough research on your chosen underlying asset classes before entering any positions. Ensure you have a sufficient budget for margin requirements and stay vigilant with market monitoring to make informed trading decisions.
  
• Trading Strategy
  Develop a disciplined trading strategy that includes risk management techniques such as setting stop-loss orders and diversifying your portfolio.
  
• Time Commitment
  Active monitoring of markets is often necessary for successful CFD trading. Be prepared to dedicate time to market analysis and trading activities.
  Remember, successful trading often hinges on disciplined risk management and staying well-informed about market conditions.

FAQs about CFDs

• How much money do you need to start CFD trading?
  Most brokers typically require a minimum deposit of approximately $100-$500 to open a CFD trading account. However, the amount necessary for effective trading varies depending on factors such as your trading strategy, risk tolerance, and financial objectives.
• Are CFDs better than investing?
  Both CFD trading and investing have their own merits and drawbacks, making it less a matter of one being superior to the other. CFD trading provides greater flexibility and the possibility of higher returns, yet it comes with higher risk and demands active monitoring. Investing, conversely, often serves as a long-term strategy offering stability and lower risk, albeit potentially lower returns.
• How long should you hold a CFD?
  The duration for holding a CFD depends on your specific trading strategy and financial objectives. Whether for short-term gains or long-term investment, it's crucial to implement a robust risk management plan to safeguard your positions effectively.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice. Trading cryptocurrency CFDs and spread bets is restricted for all UK retail clients.