New to the world of CFD trading? Understanding the terminology is your first step towards navigating financial markets with confidence. Contract for Difference (CFD) trading allows you to speculate on price movements without owning the underlying assets. Before placing your first trade, familiarise yourself with these essential terms that form the foundation of CFD trading for beginners.
What Is a Broker
A broker is the intermediary that provides you with access to financial markets. They offer the platform, execute your trades, and often provide educational resources and tools.
When you decide to trade CFDs, you’ll need to select a broker – this is the company that will provide you with a trading platform and execute your trades. Look for a regulated broker that offers strong security measures such as segregated client funds. A reputable broker would often provide educational resources, responsive customer support, and a reliable trading platform that remains stable during volatile market conditions.
What Is an Asset
An asset refers to any financial instrument you can trade, including stocks, currencies, commodities, indices, or cryptocurrencies.
As a CFD trader, you’ll select which assets to trade based on your market analysis and strategy. For example, if you’ve analysed that tech stocks are trending upward, you might choose to trade a NASDAQ index CFD. Each asset has different trading hours, volatility levels, and margin requirements that you’ll need to understand before trading.
What Is Liquidity
Liquidity describes how easily an asset can be bought or sold without affecting its market price. Higher liquidity means faster execution and typically tighter spreads.
Trading highly liquid assets means your orders get filled quickly and at prices close to what you see on your screen. For instance, EUR/USD typically has high liquidity during European and US market hours, facilitating prompt entry and exit from trades. Low liquidity markets, like some exotic currency pairs or less popular cryptocurrencies, can be riskier as price gaps and slippage are more common.
What Are Indices
Indices are measurements of the price performance of a group of shares from a particular exchange. Popular examples include the S&P 500, FTSE 100, and Nikkei 225.
Trading indices through CFDs could be a convenient way to gain exposure to entire economic sectors or regions. For instance, if you believe the Australian economy will strengthen, trading the ASX 200 gives you exposure to Australia’s largest companies without having to research and select individual stocks. Indices also typically have longer trading hours than individual stocks, giving you more flexibility in your trading.
What Is a Pip
A pip (price interest point) is the smallest price movement in a trading pair. For most currency pairs, a pip represents a price change of 0.0001.
Understanding pips is crucial for calculating your potential profits and losses. If you trade 1 lot (100,000 units) of EUR/USD and the price moves 10 pips in your favour, that translates to approximately $100 in profit (excluding fees); however, if the market moves against you, that results in a $100 loss (excluding fees). Different currency pairs have different pip values – major pairs are typically quoted to 4 decimal places, while JPY pairs use 2 decimal places. Always calculate the pip value relative to your position size before entering a trade.
What Is Commission
A commission is a fee charged by some brokers for executing trades on your behalf, typically calculated as a percentage of the trade value or as a fixed amount.
Understanding your broker’s commission structure directly impacts your trading costs. Some brokers charge a flat commission per lot traded, while others offer commission-free trading with slightly higher spreads. For example, a platform like Mitrade offers which can potentially reduce costs for frequent traders. Always factor in all trading costs when calculating your potential profitability.
What Are Commodities
Commodities are physical goods traded on exchanges, including precious metals (gold, silver), energy products (oil, natural gas), and agricultural products (wheat, coffee).
Commodities CFDs allow you to trade these essential goods without dealing with physical delivery or storage. For example, if you believe oil prices will rise due to OPEC production cuts, you can open a long position on crude oil. Commodities often react to specific economic data or seasonal patterns – agricultural products may follow harvest cycles, while energy prices often respond to inventory reports.
What Is Leverage
Leverage allows you to gain larger market exposure with a relatively small capital outlay. It’s expressed as a ratio, such as 30:1, meaning you can undertake a position 30 times the value of your margin.
While leverage can amplify returns, it similarly magnifies losses. If you open a $10,000 position using 20:1 leverage with $500 of your own capital, a 5% move against you would wipe out your entire margin. Always
What Is Margin
Margin is the deposit required to open and maintain a leveraged position. It serves as collateral to cover potential losses.
Different assets require different margin percentages. Volatile assets like cryptocurrencies might require 50% margin, while major forex pairs might need only 3.3% (30:1 leverage). Your available margin determines how many positions you can open simultaneously.
What Is a Margin Call
A margin call occurs when your account equity falls below the required maintenance margin level, prompting the broker to demand additional funds or close positions.
Receiving a margin call means your positions are moving against you and depleting your account funds. For example, if your broker requires a 100% maintenance margin level and your $5,000 account drops to $2,500, you’ll receive a margin call. To avoid margin calls, you could implement proper position sizing and risk management tools, such as a stop-loss order.
What Is Spread
The spread is the difference between the buy (ask) and sell (bid) price of an asset, representing the cost of trading.
The spread directly impacts how quickly your trade can become profitable or incur a loss. If you’re trading EUR/USD with 2 pips spread, your position must move 2 pips (excluding fees) in your favour just to break even. Spreads may widen during major news events or outside regular market hours.
What Is Volatility
Volatility measures how rapidly and significantly an asset’s price changes. Higher volatility means larger price swings in either direction.
Understanding an asset’s volatility helps you set appropriate stop-loss levels. A highly volatile cryptocurrency might require a wider stop-loss to avoid being stopped out by normal price fluctuations, while a less volatile forex pair may be managed with a tighter stop-loss due to its more stable price movements. Volatility often increases around economic data releases, earnings reports, or central bank announcements – traders may choose either to stay out of the market during these events or adjust their position sizes accordingly.
What Is Slippage
Slippage occurs when a trade executes at a price different from the expected one, typically during periods of high volatility or low liquidity.
You can encounter slippage most often during major news events or market gaps. For example, if the U.S. releases unexpected employment data, EUR/USD might gap significantly, causing your order to execute at a worse price than anticipated. To reduce slippage risk, be cautious when trading immediately before high-impact news releases and when entering market orders during volatile conditions. Using limit orders instead of market orders can help define entry prices, though they may not always be filled.
What Is a Stop Order
A stop order automatically closes your position when the market reaches a predetermined price, helping to limit potential losses.
Using stop orders is fundamental to risk management. If you buy gold at $3,300 per ounce, setting a stop order at $3,275 caps your potential loss at $25 per ounce. Consider using guaranteed stop-loss orders—if offered by your broker—for important positions, as they can provide added protection against market gaps where standard stop-loss orders may be subject to slippage. However, keep in mind that guaranteed stops may incur additional fees.
What Is a Trailing Stop
A trailing stop is a dynamic stop-loss order that automatically adjusts as the price moves in your favour, helping to lock in profits while still protecting against losses.
Unlike a standard stop order that remains fixed at a specific price, a trailing stop “trails” the market price by a set distance or percentage. If you buy gold at and set a 2% trailing stop, your stop initially sits at $3,234. If gold rises to $3,350, your stop automatically adjusts upward to $3,283, locking in some profit while maintaining the same protective distance. However, if the price then falls, your stop remains at $3,283 rather than continuing to follow downward.
By implementing a trailing stop, you can let profitable trades continue running while systematically protecting your gains from significant retracements. This removes much of the emotional decision-making surrounding the exit of trades and helps prevent the common mistake of holding on too long during reversals.
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