So here you are reading the CFD Trading Frequently Asked Question (FAQ) page. I’m sure if you’re a CFD n00b (net speak for newbie) you’ll find this page very helpful.
n00b: What CFD mean? Is CFD an abbreviation for something? What does CFD stand for?
CFD Trader: Well, CFD is an abbreviation for Contracts For Difference. And what does it mean? In simple terms, every time you press a button to start a CFD trade you are effectively entering a new contract, and the agreement in that contract means that either party to that contract either you the trader or the CFD dealer is liable to pay for any difference in the value of the underlying equity under which the contract was initiated. Is that simple enough?
n00b: I hear people talk about “going long“. What does that mean?
CFD Trader: Well unless you are looking for someone to run out further in the field to catch your pass, going long in a CFD trade means to buy the shares or stocks you believe are going to go up.
n00b: Okay, I also hear people recommending to “go short“. If go long means buying, surely shorting something is opposite?
CFD Trader: Yes! You are on the right track. To go short on a position means selling the shares or stocks you believe are going to go down in value.
n00b: So what’s an open position?
CFD Trader: Easy. It means you have an ongoing trade happening. Although it doesn’t really say if you went short or long on the position.
n00b: And when you close a position…
CFD Trader: …it means that you terminate your open trade. So to close a long position by selling and you close a short position by buying.
n00b: I hear a lot about stop loss… what are they and why are they important?
CFD Trader: A stop loss is basically a standing order at a certain price to automatically close your position. The purpose of a stop loss is not to profit, but a money management tool to limit losses in your trading.
n00b: CFD’s have are related to margin trading aren’t they?
CFD Trader: Yes it is. It is not the same as borrowing from a bank. If you are trading with CFD’s you are effectively trading on margin. The margin is the amount of money your CFD dealer requires the trader to hold while you initiate and hold an open position. The size of the margin depends on the broker and depends on the stock. Very small margins like 1-5 percent are very risky for the trader. I’ve noticed that the more distinguished firms tend to offer CFDs that require larger margins – possibly to protect the trader and the dealer from burning themselves. However, this shouldn’t stop you from trading with dealers with small margins. They are great when you have a small amount of money to play with as they magnify your effective trading capital. (The risk is that while your profits are magnified, so is your losses.)
n00b: I got a margin call the other day? What are they?
CFD Trader: A margin call is a demand from your CFD dealer to fund your account in order to maintain the margin required to hold open a position.
n00b: All I hear is risky. CFD’s = risky. Why do most people consider CFD trading more risky than trading physical shares?
CFD Trader: Why is it so risky? Because for one, there is leverage involved since you are trading on margin (see margin trading). And when there is leverage either your profits can be magnified or worse your losses magnified. Also there is the small consideration that you don’t actually own any shares – which has some other complications which are out of the scope of this FAQ.
So to all you n00bs out there… take care in your trading. Trade with a plan and stick to the plan.