Contracts for Difference – Futures & Foreign Exchange – Leveraged instruments Explained

What is a CFD A CFD is a leveraged trading instrument that allows you to trade a large numbers of shares for a smaller outlay than buying the actual stock or contract. In doing so your gains OR losses can be magnified compared to holding ‘traditional’ positions. You can trade LONG [UP] or short [DOWN- selling something and buying it back for less in the future].

Lets look at an example of trading stock ZYX….We will buy 1000 shares of ZYX at a value of $10

To purchase the real thing will cost us $10000, plus commission at around .4%.

To purchase 1000 CFDs of the same stock will only cost us $500 in ‘margin’- which we get back at the end of the trade IF we are right, Plus commission at around 1%.

This means that our R.O.I. [return on investment] is amplified much more when trading a CFD- and a WARNING- our losses can also be greater if we do not engage in sensible risk management.

Let’s assume we hold the position for 10 days and that the best brokerage rate we get is around .04% for traditional online broking and .01% with most CFD providers.

To ‘trade’ 1000 CFD’s will cost us a deposit of $500- deposits will vary anywhere from 3-20% depending on the stock and the provider, as a general rule count on 5% for the top 100 stocks.

When we ‘buy’ a CFD the provider is essentially lending us money to purchase our position. For the privilege they charge us the standard bank rate [RBA in Australia] which at time of writing is 5.75% + a ‘haircut’ of between 2 and 4%. This is a financing charge made by the provider let’s assume in our example the provider is adding 3.25% to take the interest rate to 9%. this equates to a charge of around $2.46 per day on a position size of 1000 shares.

Note when we sell short a stock the provider will PAY us interest. Though not at the same rate as when we buy usually the ‘haircut is in the 1 to 2% range so you would receive 5.75% -2%, or 3.75% on your short trade.

Dividends and adjustments:

CFD’s receive the full dividends that the normal stock does as well as any share splits or special payments. If in a short position you must pay the provider.

If we are taking a long position [planning that our share will rise] then CFD’s are a great short term option. If we bought a $10000 position and held it for a year we would need to pay $900 of interest. Similarly a Margin loan from a bank or other lending institution would charge you around 7 to 12% for the same privilege, but only lend you a maximum of 70% of the value of some shares.

FUTURES A Futures contract is an agreement to buy or sell something at a set price on a FUTURE date. I might agree to pay farmer Fred $25 for a bushel of wheat in August and it is now January… between now and January a hailstorm wipes most of the grain crop… A bushel of wheat is now worth $50, but Farmer Fred now has to sell it to me for the agreed ‘FUTURE’ we agreed on in August of $25. Similarly if there had been an over supply of wheat and it was selling for $13 a bushel to have harvested and delivered. I would still have to pay Farmer Fred $25.

A Futures contract is an AGREEMENT for payment at a set price on a future date.

Some futures contracts are DELIVERABLE. This means you do not want to be holding a contract for oil beyond the expiry date for example…. in the first place you need to cough up the cash for a barrel of oil— value $50000+, then they will come and pump it into your lounge room, unless you have a nearby oil storage facility!

Most contracts are NOT exercised, but just be aware of the time your contract terminates. Most brokers will be on the phone to you the week before- asking if you want to ‘roll’ your contract- that means getting out of the contract that is set to expire and taking up the next contract… In some cases this is monthly. Oil trades this way – expiring around the 20th of the month.

Others are bi-monthly or quarterly. The Australian Share Price Index contract or S.P.I is quarterly, March, June, September and December with expiry around the 15th of the month… you will need to KNOW these dates. Things can get volatile as contracts are ‘rolled over’ from one month to the next contract.

In Australia futures contracts are traded through the Sydney Futures Exchange- which recently merged with the Australian Stock Exchange to become the Australian Securities Exchange.

A number of Futures exchanges operate In the United States; from the East Coast to the West coast. Some of the ones you will be familiar with would be;

NYMX [New York Mercantile Exchange] this is the place where the Crude oil price you see on the news comes from- NYMX light sweet crude is the benchmark. It is traded in an open ‘pit’ session – yep, all those guys wearing funny jackets and doing funny hand signals…… trading takes place between 1000 & 1430 New York time and it then trades electronically for most of the rest of the day. We can also find Comex Gold and silver at the NYMX.

CME Chicago Mercantile exchange- home of the E-mini on the S&P 500. You can also trade Pork bellies here!

CBOT [Chicago Board of Trade] Here you can trade anything from Soybeans to Wheat and Dow futures to 10 Year Bonds

To trade coffee or sugar or frozen orange juice concentrate you need to go to NYBOT-The New York Board of Trade

Euronext is the home of London Sugar, currencies and European interest futures contracts.

To trade a futures contract you will need to open an account with a broker- this will mean a lot of form filling and declaration. After this you will deposit funds to your account. You need to make sure you have enough money to trade the ‘instrument’ you are interested in.

For example to trade corn your may need a deposit of $1000 per contract. But to trade one contract of oil requires a deposit of U.S. $5500, and the range in a trading day might be up to $3000 at $50 a point….. tread carefully.

The Contract on the share price index in Australia is the S.P.I. and currently requires a deposit of AUD $6200- and each point of movement is equivalent to AUD $25.

The S&P 500 has a big contract valued at $250 a point and a ‘mini’ otherwise known as an E-mini contract. This is one of the most liquid futures contracts in the world and is traded ONLY online.

The deposit is U.S. $$3,563 and each 100 point move = $50 so a move from 1498 to 1500 = 200 points or $100. Often the S&P can move five to ten points in a night. Sometimes an astonishing 20! That’s on just one contract.

Currencies Some CFD providers allow you to trade currencies, but when the trading is thick and fast their platforms cannot keep up to dedicated forex providers…. In my experience.

Once again it’s the leverage equation. Most Forex providers give leverage at 100:1 some at 200 to 1 and a few at 400 to 1

This means that with $1000- you can CONTROL $100000 at 100:1

$200000 at 200:1

or $400000 worth of a currency ‘pair’ at 400:1.

Scary if it goes it wrong way!

All FOREX currencies are traded as a pair- I will stick to what are known as the 4 MAJORS these are

GBP/USD- the British pound Versus the U.S. Dollar

EUR/USD- the Euro versus the U.S. Dollar- this is the most highly traded currency pair accounting for 70% of all volume and can have a ‘spread’ [buy sell difference] of only 2 pips or points

USD/CHF The U.S. Dollar versus the Swiss Franc

USD/JPY The U.S. Dollar versus the Japanese Yen

In FOREX we Buy one currency and sell another against it… lets look at GBP/USD for instance

The Standard contract size is 100K or $100,000 of the currency You are trading

If I go ‘LONG’ 1 STANDARD contract of the GBP/USD it means I am buying $100,000 worth of US Dollars and simultaneously selling $100,000 worth of British pounds. We pay a small spread- but NO commission.

If the GBP rose in value against the US dollar then to terminate our trade we would have more POUNDS- the one we bought and less DOLLARS the one we sold- so we have made a profit. That’s the basics.

The FOREX market turns over almost 2 Trillion dollars a day, this is five times the money turned over in aLL the stock markets and futures exchanges in the WORLD!. Now that’s liquidity- you will always be able to buy or sell the four majors.

Trading begins at 6am Monday in New Zealand and goes through to 0700 GMT this is known as the “Asian session”, London- which is the ‘center’ of the financial universe then comes on board until around the United states session begins around 7.30 Am New York time…….. Some interesting trading takes place at this change-over time. So the week progresses until 5pm Friday New York time when the action ceases for the weekend and resumes at 6 am New Zealand time…….

One thing to be Very aware of is the wild ranges that can occur in FOREX; these are driven by ‘news’ events- GDP figures, employment figures, Interest rate rises or announcements can all provide phenomenal spikes on 15 minute and hourly charts, which are all very trade-able and profitable…. If you have the right strategy.


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