A contract for difference (CFD) is a leveraged, derivative financial instrument which is particularly popular in both Australia and the UK. Online CFD trading is the process of buying and selling these derivatives with the aim of making a profit.
A key difference to trading in the stock market is that the trader does not own the physical asset, nor are they required to pay the full amount for the asset at the time of opening the CFD trade. Instead CFD providers require an initial margin and the amount of this is dependent on the leverage being offered by the broker. They are also only trading the difference in price between the open price and the price they close the CFD position at. This is where the term “contract” comes in as the trader is entering a contract with the CFD provider, to either receive or pay the difference in price once the CFD trade (open position) is closed.
The profit or loss made by a CFD trader is however based on the full market price of the asset, not just the smaller margin amount used to open the trade. This is critical to understand and be balanced in your approach to trading CFDs, as while leverage can magnify the gains, it will also magnify the losses too! Remember CFD and Forex trading is putting your capital at risk and it is possible to lose more than your initial deposit.
Prices of CFDs are derived from the underlying financial instrument, meaning the contract for difference will move roughly in line with the market price movements of the underlying asset. Whether the price of the contract for difference is exactly the same, or relatively close really depends on the CFD brokers pricing model. If they are direct market access (DMA) CFD broker then the bid (buy) and ask (sell) prices should exactly match the underlying market. If the broker uses a Market Maker pricing model then the bid ask CFD prices will generally be a little different and generally slightly wider than the bid ask spread of the primary market.
A benefit of trading a CFD is the ability to open a short position (aim to make money if the financial instrument drops in price) in addition to the more traditional long position (aiming to make money if the financial instrument increases in price). There is also an incredibly wide variety of financial markets to trade CFDs on. Common examples are CFDs on shares, Forex, index and commodities.
CFD Online Trading in Australia
The actual process of how CFDs work or are traded is no different in Australia compared to other countries. Key differences Aussie traders will notice are the CFD providers operating in Australia, the government body regulating the CFD industry and some of the terminology will be a little different.
Australians have embraced the CFD market and it is generally regarded as being well regulated by the Australian Securities and Investments Commission (ASIC). Australia has a number of “home grown” Australian CFD brokers such as FP Markets, in addition to many of the well known global brokers such as IG and CMC Markets. In the Australian market you’ll notice that some common terms used in the UK, such as spread betting, are not allowed to be used.
When starting out , it is advisable for new traders to try one of the free demo trading accounts generally offered by CFD providers. These enable you to give their CFD trading platform a test run before opening a live trading account and also confirm if it has all the features and functions your trading style requires. For example, if you use technical analysis to study the price movements on a chart then confirming that all the technical indicators and design of the charts is suitable for you. It’s important to ensure that you always feel comfortable using the trading platform as the last thing you want is to be “wrestling” with the platform while quickly entering or exiting a trade. A demo CFD account is generally available for 28 days or 1 month period, however some brokers may offer untimed demo accounts which is useful for testing out your CFD trading strategy prior to putting your hard earned money on the table.