CFDs Contracts For Difference
This term is a broad description covering trading activity that is not purchase based. Traditionally profit was achieved through the purchase of e.g. shares and subsequent selling at a later date for a higher price. With CFD the stock or ‘product’ is not actually bought, its performance of a period of time is merely speculated on. In simple terms, a CFD is a near enough a ‘gambling contract’. You bet that the price of an instrument (i.e. stock, currency or commodity) will be different over a period of time. You will profit if correct, lose if incorrect. You are entering into a contract with the provider that they will pay you, or you will pay them based on your predictions of a stock price rising or falling over a period of time, not on your purchase of the stocks.
Prices on the Forex and other markets can change outside of ‘standard trading hours’. This is because banks continue to trade, and events such as e.g. an earthquake, can have an effect on the value of one currency against another. The term gapping refers to the difference between the price of an instrument at the close of the market, and the opening of the market the next day, or over the weekend. If you are only trading on an daily basis this is not a problem. But, if you are interday trading, or leaving a position open over the weekend then this can have an effect even on a stop loss protected trade. If you set a stop loss at e.g. 1.3890 on EUR/USD, and the market opens on Monday morning at 1.3940, that’s a leap of 50 points past your stop loss. Gaps ‘usually’ recover, but if you have to close the trade there and then, that’s a potential loss. Guaranteed stop losses do exist, however as they are a form of insurance, they do come with a premium.
An instrument is a trading term for anything that you can place a bet on – a horse, a currency, a stock.
Leverage Or Gearing Up
‘Leverage’ describes when you increase the value of your stake, without actually putting more money on the trade. For example with Forex trading, you can have up to 400 times the value of your stake, which is how you can profit without having to put the full stake or ‘margin’ down. With Spread betting, leverage is far more profitable (and potentially dangerous) this is because Forex is based on ‘Lot Sizes’, whereas with spread betting leverage is a flat rate based on the the instrument that you are betting on.
Forex trading is done in lots. Without going into too much detail, the lots have to be defined in packages. You wouldn’t ring up a wholesalers and ask for 863 tins of beans, you would do it in multiples of 100 or 500. Same with Forex. The lot size on the account you open defines how much you can win. The higher the lot size, the more cash you need to open the account, and the more profit you can make. On a mini lot, you may trade with 10,000 units, and each pip move is equivalent to 1 Dollar. For beginners there are micro lots that can start as low as 1,000 units, but a 1 pip move would only be equivalent to 10 cents.
Margin is what is required to open a spread-bet. You will be required to ‘cover’ the bet if it goes in the wrong direction. This is a major difference with Forex. If you use leverage, you are required to cover that bet should it go the wrong way, which can be potentially costly. To open a bet you may need up to 400 times your stake placed in your account. The downside of this is that you can lose all that money. The upside is that the bet is held open if the stock or currency is temporarily going in the wrong direction, allowing you to profit even though your chosen stock may briefly ‘blip’ in the wrong direction. This is in contrast to Forex, where you may have the bet closed and lose your stake instantly if it briefly ‘flickers’ in the wrong direction. So how much margin is required? it all depends on what you are betting on. See NTR below.
Notional Trading Requirement (NTR)
The size of your required margin is based on your stake multiplied by the NTR for your chosen instrument (e.g gold). The NTR is calculated by the trading provider and is in the main based on the volatility of what you are betting on. The more volatile the stock the higher the NTR. If you are betting on the Nikkei which is quite volatile, the potential for profit is huge and so is the poential for loss. Betting on the Nikkei will be subject to a higher NTR.
The Min IMR is a spread-betting term that refers to the Minimum Initial Margin Requirement. Much the same as NTR, it is a calculation based on the volatility of the stock, and informs traders as to the amount of margin required to place and cover a bet. Most ‘instrument’ or ‘products’ have a different Min IMR and this will vary between brokers, for example Gold can have an IMR of 100, and the EUR/USD can be 40. So, if you open a bet on the EUR/USD with $10, you will need $400 to cover the bet ( stake 10 x Min IMR 40 = 400)
One pip is generally the fourth decimal point of an instrument(i.e. 0.0001), for example if the EUR/USD moves from 1.3890 to 1.3895, that’s a move of 5 pips. However, with the YEN, the pip is 0.01, make sure you do understand this fully before trading with the YEN.
This means that you bet on e.g. a stock going up in value within a given timescale. This is the traditionally understood and theoretically most straightforward element of dipping into the stock and currency markets – buy low, sell high! But remember you don’t actually own the stock/currency.
Selling/Betting Short (also known as ‘backing and laying’)
This means that you bet that something is going to go down rather than up. Buy high, sell low – what?? So how does it work that I am betting on something going down, and I appear to actually be borrowing it and selling it back at a lower price? How does that make a profit? Don’t get overly concerned with the mechanics of market, all that matters is that you if you bet on something going down and you are right, you profit. A comedy writer does not spend time learning about how televisions work, they spend their time concentrating on getting the funnies out. Similarly, you don’t really need to know how it all works unless you intend to open your own Forex Broking Company. Our advice is to spend any available research time figuring out which are potentially the most profitable and safest trades to open. However, if you are really interested in the theory behind making a profit from shorting, check out wikipedia as a starting point.
The spread is a term that applies to most forms of trading. Lets Say the price of EUR/USD is set at BUY 1.3972 or SELL 1.3969, the difference of 3 pips is the spread, and it is where most brokers make their profit (although some will charge commission on wins depending on the platform that you are trading and the broker).
This refers to the strategy of trading over relatively short periods of between a day or a week.