CFD trading is an admired way to trade financial markets in Australia. A CFD stands for Contract for Difference, and it is a type of derivative that allows traders to wager on an underlying asset’s price movement without owning the asset itself. It makes CFDs an attractive proposition for many traders, as they can gain exposure to a wide range of markets with relatively little capital.
However, CFD trading is not without risks, and it is essential to understand these before entering any trades.
How do CFDs work?
When trading a CFD, you effectively enter a contract with your broker to buy or sell an underlying asset at a predetermined price. If the market moves in your desired direction, you will profit; if it moves against you, you will incur a loss.
For example, let’s say that you believe the price of gold will rise next month. You could open a CFD trade to buy gold at $1,300 per ounce. If the price of gold increases to $1,400 per ounce during the month, you will make a profit of $100 per ounce (minus any commissions or fees charged by your broker). Similarly, if the price of gold falls to $1,200 per ounce, you would incur a loss of $100 per ounce.
The critical thing to remember with CFDs is that you are speculating on price movements rather than buying or selling the underlying asset. You will never own the asset and only profit or lose money based on price movements.
What assets can you trade with CFDs in Australia?
Traders can use CFDs to trade a wide range of underlying markets, including:
- Commodities: such as gold, silver, oil, and natural gas
- Indices: such as the ASX 200, Dow Jones Industrial Average (DJIA) and S&P 500
- Currencies: such as the Australian dollar (AUD), US dollar (USD), and Euro (EUR)
- Shares: such as those listed on the ASX
- Treasuries: such as government bonds
When trading CFDs in Australia, you can choose from a wide range of assets. However, it is essential to remember that you are speculating on price movements rather than buying or selling the underlying asset.
The appeal of CFD trading is that you can trade a wide range of markets from one account. This diversification can help reduce your overall risk, as you are not putting all your eggs in one basket. You can also speculate on price movements regardless of whether the market is rising or falling, so you can find more opportunities and get more out of trading.
What are the risks involved in CFD trading?
Volatility
The first thing to be aware of is that CFD trading is a speculative activity with a certain amount of risk. One of the key risks involved is volatility, which refers to the fluctuations in price that an asset experiences over time. These fluctuations can be sudden and dramatic and can easily lead to losses if you are not careful.
For example, let’s say that you believe the price of oil is going to rise in the next month. You open a CFD trade to buy oil at $60 per barrel. However, the price unexpectedly falls to $50 per barrel during the month. It would result in a loss of $10 per barrel (minus any commissions or fees charged by your broker).
Leverage
Another critical risk to be aware of is the use of leverage. Leverage is using borrowed capital to magnify potential profits (and losses). CFDs are leveraged products. This means that when you trade CFDs, you can use leverage to gain exposure to more significant positions than you would be able to with your capital.
For example, let’s say that you have $5,000 in your trading account and want to trade the Dow Jones Industrial Average (DJIA). The DJIA is currently trading at 25,000 points. If you were to trade the DJIA without leverage, you would only be able to buy 200 points worth of the index ($5,000/$25,000).
However, if you were to trade with a leverage of 10:1, you would be able to buy 2,000 points worth of the index ($5,000 x 10). It would give you ten times more market exposure than if you were trading without leverage.
Getting started with CFD trading
If you are interested in trading CFDs, you can get started by opening an account with any trusted and reputable broker that is licensed with the ASIC. Once you have an account, you can fund it and gain access to diverse global markets, provided that your broker offers the instruments you want to trade. You can read more about CFDs here if you would prefer to learn more before making a move.
