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What is a CFD?

CFDs were first introduced to Australia at the start of the millennium and have since been fast becoming a mainstream trading instrument. Due to their cost effectiveness and relative simplicity – they have overtaken considerable portions of the options, futures and even share markets.

Considered the most versatile of all products; they are most popular for trading shares and share indices although they have also become widely used to trade commodities and even FX.

Key considerations:
  • Relatively simple compared to other derivatives
  • CFDs prices directly follow the asset that they are based upon
  • Are used to trade almost all other markets (local & international shares, futures – especially indices – & FX)
  • Can be used to potentially profit from falling markets via short-selling
  • Easy access to global markets from a single, Australian-dollar based account
    24-hour trading opportunities
  • Relatively low cost – many contracts are commission-free (spread-based)
  • Can be traded using high leverage – increases risk and reward potential

 

Making a CFD trade is very much like trading the underlying asset itself, but with less restrictions and some key benefits. The main attraction of CFDs is leverage as it allows traders to maximise their available capital.

For example, if you thought that a particular stock was going up (lets say Rio Tinto) then you could take a $10,000 trade on RIO using just $500 of your trading account. This initial outlay is known as margin.

If RIO were to increase in value by 15% then you could sell your CFDs for a $1500 profit, as if you bought and sold the shares themselves.

CFD providers also provide a range of risk management tools such as stop-loss orders and orders to automatically take profit. As with all trading (but particularly when leverage is involved), risk management is the key to long-term success.
Some brokers will even offer guaranteed stop losses which completely limits your loss if the trade goes the wrong way (even if the share drops to zero overnight).

Most Australian CFD providers offer their clients access to several thousand markets around the globe which all can be traded through a single trading platform, and from a single Australian-dollar account, without the need for currency conversions.

“If you invest and don’t diversify, you’re literally throwing out money. People don’t realize that diversification is beneficial even if it reduces your return. Why? Because it reduces your risk even more. Therefore, if you diversify and then use margin to increase your leverage to a risk level equivalent to that of a nondiversified position, your return will probably be greater.” – Jeff Yass

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