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CFD Trading

CFD Trading Comprehensive Guide

 

TABLE OF CONTENTS

CFD TRADING

Introduction 

PART 01: So what the heck is a CFD, anyway?

Differences Between Buying CFDs and Various Underlying Assets
  Share CFDs
  Commodity CFDs
  Foreign Exchange CFDs
  Index CFDs
So Should I, Or Shouldn’t I Invest In CFDs?
Basics Of CFD Trading
Part 01 – Key Points To Remember


PART 02: Understanding CFD Trading Costs

Brokerage Fees
   On-Line Trading
   Over The Phone Trading
   Full Service Firms

Beware Of Promises About Commission Free Trading!
Paying The Spread
CFD Financing
Foreign Currency Exposure
How Corporate Actions Affect You
  What About Dividends?
  What About Stock Splits?
  What If A Company Goes Bankrupt?
The Tax Implications of CFDs
Part 02 – Key Points To Remember 


PART 03: Getting Started Investing In CFDs

Direct Market Access CFDs
   Advantages of DMA CFDs
   Disadvantages of DMA CFDs
 Market-Maker CFDs
   Advantages of Market Maker CFDs.
   Disadvantages of Market Maker CFDs
DMA Vs. Market Maker – Which One Is Right For You?
Finding The Right Broker
Questions t o Ask Of A Potential Broker
Opening An Account
Types Of Accounts
   Individual Account
   Joint Account
   Company Account
   Trust Account or SMSF
   Limited Risk Account
Funding Your Account
Self-Assessment – Which CFD Market Is The Best Fit For You?
Before You Make Your First Trade
Defining A Basic Investment Strategy
   Market Entry Criterion
   Your Money Management Plan
   Understanding The Risk vs. Reward Tradeoff
   Your Exit Criterion – Know When To Hold ‘em, Know When To Fold ‘em
Fine Tuning Your Strategy
   Controlling Leverage
   Tools Of The Trade
Part 03 – Key Points To Remember


PART 04: Where The Rubber Meets The Road – Your First Trade

The Value Of A Demo Account
Differences To Be Aware Of – Live Demo vs. Actual Trading
What Kinds Of Orders Can You Place?
   Market Orders
   Limit Orders
   Stop Orders
   OCO Orders
   If Done Orders
What The Heck Is a Requote, Anyway?
Part 04 – Key Points To Remember

 

PART 05: Critical Trading Skills

Analysis
Economic Analysis
Technical Analysis
Fundamental Analysis
Quantitative Analysis
Proper Position Sizing
Market Movement
Managing and Mitigating Losses
Scaling
Profit Taking
Re-Entry
Part 05 – Key Points To Remember
 

PART 06: Refining Your Trading Strategy

Calculating Risk
Pivot Tables
Equity Curves
Managing Drawdown
Keeping Accurate Records!
Part Six – Key Points To Remember

PART 07: Here There Be Dragons – Common Mistakes To Avoid

Uncontrolled Losses
Too Much, Too Soon
Being Driven By Fear Or Greed
Forgetting To Lock In Profits
No Reentry
Putting Stock In Untested Ideas
Chasing Entries
Overtrading
Eliminating Mistakes
Part Seven – Key Points To Remember 2

PART 08: Your Blueprint For Success

Contents list to come
Part Eight – Key Points To Remember

Glossary of Terms


 

INTRODUCTION



Hello and welcome! 

Before we get started, there are a couple things you should know.  First, this is going to be a very long, detailed post!  If you’re daunted by content-rich posts, then this one isn’t for you, but if you’re reading these words, then odds are you’ve at least heard of CFDs before, and want to know what all the fuss is about.

Even if you’re not quite sure what CFDs are, rest assured that you’ve come to the right place!

In the sections that follow, we’ll outline in detail not only what they are, but how you can use them to make a lot of money.  Depending on how good a trader you are, you can make a life-changing amount of money!

But that is getting way ahead of the game.  We’ll start simply, by explaining what a CFD is, why it matters, and outlining some of the terms you’ll need to get familiar with if you’re planning on buying and selling them, and you should.  They represent a fantastic investment opportunity for newbies and seasoned investors alike.

Ready?  Let’s get started!

 




PART 01:  SO WHAT THE HECK IS A CFD, ANYWAY?

 

Differences Between Buying CFDs and Various Underlying Assets
  Share CFDs
  Commodity CFDs
  Foreign Exchange CFDs
  Index CFDs
So Should I, Or Shouldn’t I Invest In CFDs?
Basics Of CFD Trading
Part 01 – Key Points To Remember

We’ll take it from the top, in case you’re new to the world of investing and aren’t sure what the acronym means.  CFD stands for Contract For Difference.

As the name implies, it’s a contract between you and a broker who sells CFDs, with your profit or loss being the difference in price between the time when a trade is entered into, and then time when you exit the trade.  You’re literally exchanging the difference between those two values with your broker.

There are all sorts of CFDs including:

  • Commodity CFDs (contracts that track specific commodities like soybeans, wheat, oil, etc.)
  • Foreign Exchange CFDs (contracts that track currency pairs)
  • Index CFDs (contracts that track a specific index, like the S&P500, the XJO, etc.)
  • And Share CFDs (contracts that track the stock of a specific company)

As a contract, this is not the same thing as simply buying a share of stock in a particular company, although the CFD’s price mirrors the actual stock price, moving in the same direction, because the CFD's value is based on the underlying asset.

The first question you might ask then, is why bother to buy a CFD if you can just buy the asset itself?

It’s an excellent question.  The main reason is that CFD margins are smaller, which means you have to spend less money to control the asset in question.

The best way to see this is to look at a conjectural example.

Let’s say you’re buying 100 shares of stock at $25. The total value of that investment is $2500.  A traditional broker usually uses a 50% margin, which means that you need 50% of the value of the asset to make the purchase, or $1250.

Now let’s look at the numbers if you buy a CFD, rather than the stock itself.  Most CFD brokers only use a 5% margin, which means that you could buy the same investment with an outlay of just $125.  Big difference, right?  Which means that you can buy a lot more investments with whatever amount of money you’ve got.

Let’s start the clock and move through time, beginning from the point when you finalize your purchase.

Your broker gets a commission called the spread. Let’s say the spread is 5 cents, so if the underlying stock appreciates by 5 cents after you enter into the contract, congratulations!  You just broke even.  If the underlying stock continues to appreciate, everything after that is pure profit when you close out the contract (sell).  So let’s say the stock appreciates to $26. You’d see a profit of $0.95 per share, 100 shares, or $95 ($1.00, minus the 5 cent spread).

What we’re really talking about here then is leverage.  That’s the biggest advantage that CFDs offer over more traditional investments.  The smaller the margin, the more leverage you’ve got, which allows you to control more assets with less money, and that’s huge.

Here are some of the other key advantages to CFD trading in general:

  • Global Reach – Most CFD brokers offer products from all over the world.  That means one-stop shopping for you.  You can take advantage of any opportunity from most of the world’s major markets, without ever leaving your broker’s platform.
  • Fewer Rules and Regulations – Sometimes, depending on what, exactly, you are buying, you’ll face a dizzying array of rules about what you can and can’t do.  Many instruments, for instance, prohibit short selling at certain times, or have different margin requirements. 
    While you’ll find a few rules in the world of CFDs, they are generally very few in number, and won’t cramp your style.  This is especially true when selling short, because since you don’t actually own the underlying asset, you can short CFDs at any time.
  • Full Service – Most CFD brokers offer the same types of trades as traditional brokers, including, but not limited to:  Stops, limits, and congruent orders, and possibly (but not always) guaranteed stops.
  • Extremely Low Fees – The fees charged by CFD brokers tend to be significantly lower than the fees charged by traditional brokers.  An important rule of business is “keep your fixed costs low,” and low fees = low overhead costs for you!
  •  No Day Trading Requirement – This is huge.  Some markets require a minimum amount of capital if you want to day trade, and the dollar value is usually pretty high, which shuts many novice investors out of the game entirely.
    That’s not the case with CFDs.  Accounts can be opened for as little as $1000 in some cases, although this will vary from one broker to the next, with some brokers requiring up to $5000 to set up an account.  Even so, this is a fairly modest sum by comparison.
  • Lots of Different Trading Options – See above, re: the different types of CFDs you can invest in.  You have a full menu of choices available, and aren’t restricted to just trading in stock CFDs (although stock CFDs are a great way to get your feet wet!)

It all sounds almost too good to be true, and it’s true that CFDs represent a tremendous investment opportunity, but…and you knew there’d be a “but,” didn’t you?  There are downsides, and before you jump into the world of CFD trading, you need to be aware of them.

The first downside is the spread.  Because you have to pay the spread, it means that CFDs aren’t very good if you’re after micro-profits…that is to say, tiny movements in price from one hour to the next.  The spread will invariably eat those kinds of profits up, and if you try to take advantage of small moves like that, you’ll consistently lose money.

The other big disadvantage is something we’ve talked about before:  Leverage.

Leverage is a two-edged sword.  When you trade at a profit, leverage will magnify the return on your investment, but don’t get cocky!  The same leverage that helps you when you’re winning can burn you badly on losing trades, where they magnify your losses, which means you’ve got to be very careful to manage your risk if you want to be successful.

Later on, we’ll talk at some length about things you can do and strategies you can employ to help minimize your risks.  For now, it’s enough to be aware that they exist.  When used correctly, leverage can be a powerful tool that will help you achieve your goals much more quickly than would otherwise be possible.

BACK TO PART 01 CONTENTS


Differences Between Buying CFDs And Various Underlying Assets

Earlier, we listed various types of CFDs you can purchase, and now that you’ve got a better understanding of what they are in general, we need to spend some time talking about how each of those types differ from simply buying the underlying asset.


Share CFDs

We’ll talk about share CFDs first, because they’re the easiest to understand and are where most people start out when beginning to invest in CFDs.

If you’ve purchased stocks, then you already know just about everything you need to know about buying share CFDs.  The process is functionally similar, but there are some important differences to be mindful of.  These include:

  • No ownership – when you buy a share of a company’s stock you physically own a tiny portion of the company in question.  That’s not the case when you buy a share CFD.  You simply own a contract that is in no way connected to the company’s stock (the underlying asset), even though the price of the CFD mirrors the company’s stock price.
  • Much lower commissions – Buying stock carries much higher commission rates than buying share CFDs.  Expect to pay about half commission rate.  That’s huge, because lower commissions equal higher potential profits for you.
  • Lower margins – We mentioned this above.  Many stock brokers require as much as a 50% margin.  CFD brokers require something closer to five (and sometimes less!).
  • Financing – A small fee your broker may charge you to hold a position overnight


Commodity CFDs

As we mentioned earlier, for any commodity you can buy outright on the market, you can buy a CFD.  We mentioned a few earlier, but here’s a more comprehensive list, in case you’ve never traded in commodities before:

Cattle  |  Cocoa | Coffee | Copper | Corn | Cotton | Gasoline | Gold | Hogs | Lumber | Oats | Oil | Palladium | Platinum | Pork Bellies | Silver | Soy Beans | Sugar | Wheat

And so on.  As you can see, there’s no shortage of options here, and this is only a partial list!

So the next logical question is, “What exactly is a commodity?”  You already know that Commodity CFDs are contacts that track the underlying asset, but if you’re considering trading in Commodity CFDs then you need to understand the underlying product as well!

To that end, here’s the shortest, simplest definition of a commodity.

It’s a hard asset.  A physical product people purchase on futures markets.  They’re bought, sold, and traded in large quantity with uniform quality.  What that means is that anything on this list can be made, grown, mined or generated anywhere in the world, but the uniform quality ensures that no matter where the good is produced, an apples-to-apples comparison can be made.

Here are the key differences to keep in mind when purchasing a Commodity CFD versus purchasing the underlying commodity itself:

  •  When you buy a commodity outright, it will come with an expiry date, something you don’t have to worry about when you buy a Commodity CFD
  • If you want to break into the commodities market directly, be prepared to spend a ton of money.  $20,000 is considered a pretty small contract, and they can run to about ten times that value.  For most investors who are just starting out, that’s a lot of money!  Again, Commodity CFDs can be purchased with a much smaller outlay
  •  Charting – If you don’t have a lot of exposure to commodities trading, then you’re probably going to want to read this twice.  Commodities are priced on the futures market, but all the contracts traded on the futures market have a different expiry date.  This can be seen on comprehensive pricing charts that track commodity prices.  The charts used for commodity pricing display two months’ worth of information, but Commodity CFD pricing is based only on the current month.  If you want to base your buying and selling decisions on more complete information, then in most cases, you’ll need to get that information from a source other than your CFD Broker.

Note:  Commodity CFDs are NOT recommended for people who are new to CFDs in general.  You need to have a deep understanding of the general commodities market and what you’re indirectly trading in before wading into these waters!


BACK TO PART 01 CONTENTS

Foreign Exchange CFDs

You’ve probably heard the term “Forex.”  That’s the shorthand used when referencing currency exchanges, and in particular, simultaneously buying one currency, then selling another currency to profit from the movement between a given currency pair.

In many ways, currency trading is a lot like a drug.  Its fast paced and always on.  Since currency trading isn’t done through a central exchange, you can do it 24/7.  There is no “closing bell” here, and fortunes can be made and lost in the blink of an eye.  It’s seldom that someone buys a currency position and holds it for more than a day.  Often, they’re closed back out within hours, minutes, or even seconds.

It’s explosively volatile, and is the single largest over the counter market on the planet.  To give you an idea of just how much money flows through the market on a daily basis, in 2010, the Bank for International Settlements reported that the average daily forex turnover was just shy of $4 Trillion dollars.  Yes, that’s “Trillion,” with a “T.”  That’s huge.  Nothing else even comes close.

The foundation of currency exchanges are currency pairs, and these come in two flavors:  Pairs and Crosses. 
Here are the major currency pairs:

  • EUR | USD
  • GPB | USD
  • USD | CHF
  • USD | JPY
  • USD | CAD
  • AUD | USD
  • NZD | USD

And here are the crosses. 
Crosses are different from major pairings in that the US Dollar is entirely absent from the pairing:

  • EUR | CHF
  • EUR | GBP
  • GBP | AUD
  • AUD | JPY

The position of the currency in each pairing matters.  The first currency listed in the pairing is called the Base Currency (also known as the Primary Currency), and the second is called the Quote Currency.  Currency pairs are quoted out to four decimal places, and each point of movement is referred to as a “Pip.”

Here’s how the terminology is used.  Let’s say that for the pairing AUD à USD, the price is .9400.  If the price moves to .9401, then it has moved one pip.  This lies at the bedrock of forex trading.

When trading currency, the prices you see listed on your broker’s information screen come from the biggest banks and corporations on the planet who are moving hundreds of millions, if not billions of dollars at a time.  This is literally the grease that keeps the wheels of international trade and investment turning, and either directly or indirectly, you can be a part of it, if you want to.

There are some seriously compelling reasons to want to, even though it is a highly speculative market. 
Its major advantages are:

  • It’s an “always on” market, with no closing bell
  • Has extremely low margins, paired with flexible position sizes
  • Is entirely commission free
  • And it’s the most liquid market on the planet

All of those are good things, and compelling reasons to consider jumping in, but of course there’s a downside.

All that volatility carries with it extraordinary risk.  It takes a steady hand and nerves of steel (and preferably a huge supply of Red Bull, strong coffee, or other highly caffeinated drink) if you want to do well here, and for these reasons, it’s not a good fit for the novice investor.

Our advice would be to get your feet wet via Share or Index CFDs, learn how to make money consistently there, then perhaps move into strategic Commodity CFD trading, and only once you’ve mastered that should you consider jumping into the wild and wooly world of Foreign Exchange CFDs.


BACK TO PART 01 CONTENTS

Index CFDs

Index CFDs are functionally quite similar to Share CFDs, but where the latter track against shares of a particular company, the former track against an index, so what is an index, exactly?

Simply put, it’s a group of shares in companies that have a common element.  That commonality could be that they’re all tech companies, or all pharmaceutical companies, or something else.

The Dow Jones Index is comprised of the 30 biggest companies in America, and the price of the index is weighted according to the size of each of the companies that make up the index.  Put another way, if the majority of the shares in the companies that make up the index rise, then the value of the index will rise in tandem.  If a majority of those shares fall, then the value of the index will fall by a corresponding amount.

If you’ve had at least some exposure to the world of investing, then you’ve probably heard of Index Funds.  These are funds that buy stocks in the companies of a particular index, and see their performance mirror the performance of the index as a whole.

They’re great investment opportunities, because by buying into an index fund, you automatically gain a certain amount of diversity in your portfolio that you simply don’t get if you buy stocks in one specific company.

Index CFDs offer the same basic advantages, which makes them a compelling choice to consider, and not markedly different from Share CFDs, which means that they’re newbie friendly.  Another huge plus.

Here are some of the bigger indexes from around the world that you may have heard of:

  • Australia’s XJO
  • China’s Shanghai Composite
  • France’s CAC 40
  • Germany’s DAX
  • Hong Kong’s Hang Seng
  • Japan’s Nikkei Index
  • Singapore’s Straits Times
  • The UK’s FTSE
  • The US’ NASDAQ
  • The US’ Russell 2000
  • The US’ S&P 500

Not only are Index CFDs a great way to help diversify your investment portfolio, they’re also ideal if you think that the economy of a given country is going to generally do well, but you’re short on company-specific research.  This way, you don’t need it and can still reap the benefits.

BACK TO PART 01 CONTENTS



So, should I or shouldn't I invest in CFDs?

Now that you know what CFDs are and what basic flavors they come in, the next question is about you.  You may or may not be well suited to investing in CFDs, and it’s important to be honest with and about yourself when making the decision.

Personally, we love CFDs, so please don’t think we’re trying to dissuade you from taking the plunge, but as much as we love them, we also want to make sure they’re a good fit for you, so as to maximize your chances of making consistent profits.

With that in mind, here are some reasons you SHOULDN’T invest in CFDs:

  • If you don’t understand basic market mechanics, hold off on adding CFDs to your portfolio.  It doesn’t require a ton of experience to invest in them successfully, but you absolutely need a firm grasp of the basics of buying and selling on the market.  If you don’t have that, get your feet wet with stock purchases and master that before moving on to CFDs.
  • Ignorance of the hidden dangers of leverage.  One of the most common mistakes that novice investors make is underestimating their exposure.  This happens because they fail to take into account how leveraged their positions are.  As we said earlier, if you make a profitable trade, leverage will magnify your gains, but if you come out on the losing end, it will also magnify your losses.  More novice investors than we can count have seen the value of their accounts wiped out because they didn’t properly account for the impact of leverage on their positions and failed to manage their risk accordingly.  Until you’re sure you’ve got a firm handle on that, it’s best to steer clear of CFDs
  • If you’re driven by your emotions.  This is where so many investors, novices and veterans alike can sometimes go astray.  If you don’t take anything else from this guide, then take this lesson to heart:  Emotions have no place in investing.
    If you’re not investing dispassionately, then CFDs are not for you.  You need to create a cogent, comprehensive strategy and have the discipline to stick with it, regardless of what you’re feeling emotionally.  You need to be able to say goodbye to an investment that’s losing money, rather than try to ride it out because you have some kind of emotional attachment to the investment, or the company the investment relates to.
    Sometimes, companies we love and care about make bad calls.  When that happens, the market punishes them for it.  If you’re too close to the issue, emotionally, then you’ll take a drubbing, right along with the company in question. 
    Don’t allow that to happen to you.  Build your strategy around your risk-tolerance, then stick with it, no matter what.  Until and unless you can do that, then sadly, you’re not ready to invest in CFDs, and if you do, you’ll likely lose more money than you make.

For the purposes of the rest of this guide, we’re going to make the assumption that you’ve done some soul searching and self-analysis, and have reached the conclusion that CFDs are a good fit for you.

If that’s the case, congratulations, and we hope you’ll find what comes next to be of value.


BACK TO PART 01 CONTENTS

Basics of CFD Trading

There are two ways you can trade CFDs, and you need to be fluent in both.  They are trading long and trading short.

The difference is as follows:

A long trade is just like when you buy a share of stock.  The key idea behind it is to buy low and sell high.  That is to say, you buy when your data tells you that the value of the CFD in question is set to rise.

A short trade is the flip side of that equation.  In that case, you’re selling high, then buying low.  Essentially, you’re selling something you don’t own with the expectation that the price will drop, then buy it back at the lower price and pocketing the difference.

Obviously, there’s a lot more to successful trading than just this (and we’ll be going into a lot more depth in later sections), but this is the foundation of your entire investing enterprise. 

These two things allow you to make profits, no matter which way the market is moving.  If you only focus on one, then you’re limiting yourself to only being able to generate consistent profits when the market is moving in a single direction, and that’s not good because it will limit your success.

You don’t want your success to be limited by anything, so take the time to master both types of buying and selling, and while we’re on the subject of your success, here’s something else to keep in mind, especially if you’re a novice investor:

Don’t get into the game thinking that you’re going to make money on every single trade.

You won’t.

No one does.

The reality is that even the best, most successful investors in the world only succeed in turning a profit on about sixty percent of their trades.

Think about that for a second, then phrase it another way:  The best guys in the world fail four times out of ten.

That’s true not just in the world of investing, but in just about everything.

Take baseball, for example. The best guys in the league bat around .300.  That means that they successfully hit the ball about three times in ten, or put another way, they fail about 70% of the time.  Keep in mind that these are the best players in the world, and on top of the game.

The point of all this is simply to outline that failure happens, even to the best of the best, and honestly, it happens a lot.

The difference between a successful investor and a failed investor isn’t that one is flawless and the other isn’t, it’s that the successful investor takes steps to minimize his exposure to loss and keeps playing, while the failed investor lets his emotions take over until he loses everything, and then, simply can’t afford to play anymore.

The biggest secret to your early success is simply this:
Keep your positions small until you really get a feel for the market.

The second biggest secret is that from day one, you should be
treating your investment portfolio like a business.

All businesses exist in order to make a profit.  If they don’t do that, then they soon cease to exist, just as you will cease to be an investor unless you consistently make a profit.

By viewing your portfolio as a business, you’ll go a long way toward putting yourself in a constructive frame of mind.  One that will help install the discipline you’ll need to find long term success.

We’ll be building on both of these ideas in later sections, as we walk you through developing your own trading strategy, but to give you a sneak peek, and using the first “secret” we mentioned, if you’re not sure or not as confident about a given position, go small.  If you’re very sure, then go bigger (but still not too big).

By varying the sizes of your positions based on your confidence level, you can help minimize your risk, and when you do suffer losses, they’ll be both minimal and manageable. 

In the sections that follow, we’re going to outline the ins and outs of investing in CFDs, but then, we’re going to move beyond just that and show you how to build the investment strategy we referenced just above.

Once you’re armed with that information, you’ll be primed for success, and should consistently make profits with your CFD positions.

Before we do that though, let’s summarize.

BACK TO PART 01 CONTENTS



Part 01: Key Points to Remember

  1. CFDs are a type of derivative, because their value is determined by something else (in this case, the underlying asset, whose price movement it mirrors)
  2. The basics of CFD trading involve long trades (buy low, sell high) and short trading (sell high, buy low)
  3. If you opt to trade in CFDs, then you’ll face fewer rules, regulations and restrictions than with most other types of investments
  4. CFD Brokers also charge smaller fees, and allow you to use more leverage
  5. Leverage is a two-edged sword, and one you should be extremely careful of.  When you’re successful, leverage will make you even more so.  When you fail, it will also magnify your losses.
  6. When first starting out, it’s best to keep your positions small, until you have a good feel for the market.  In fact, varying the sizes of your positions based on your confidence level is a key component to a successful investment strategy, but we’ll cover the particulars of that in a later section
  7. From the very beginning, you should view your investment portfolio as a business.  This will help train your brain to approach investing with discipline, and it will plant the seeds for your long-term success.
  8. CFDs aren’t for everyone.  You should have some basic familiarity with the way markets, buying and selling work before jumping in.  You should also fully understand the implications of leverage and be disciplined enough to stick to your investment strategy and not allow your emotions to rule your decision making.

BACK TO PART 01 CONTENTS


 


PART 02: UNDERSTANDING CFD TRADING COSTS

 

Brokerage Fees
   On-Line Trading
   Over The Phone Trading
   Full Service Firms

Beware Of Promises About Commission Free Trading!
Paying The Spread
CFD Financing
Foreign Currency Exposure
How Corporate Actions Affect You
  What About Dividends?
  What About Stock Splits?
  What If A Company Goes Bankrupt?
The Tax Implications of CFDs
Part 02 – Key Points To Remember 


Having covered the basics, now it’s time to start digging a bit deeper, and in this section, we’re going to be taking a closer look at one very important aspect of CFDs that doesn’t get a lot of press.  It’s not sexy or glamorous, and it’s not terribly exciting to think about, but it really matters in terms of your overall level of success.

We're talking about costs.

Remember in the last section where we talked about the importance of treating your investment portfolio like a business?  Well, this is the first of many times we’ll be going back to this.

No business can find long term success unless it keeps a watchful eye on its overhead costs.  In terms of your investment portfolio, keeping your costs low is every bit as important as formulating a winning strategy, and can sometimes mean the difference between making money on a given trade, and losing money.

Therefore, it’s extremely important to thoroughly understand what your costs are, and what kinds of things are driving them.  That’s what this section is all about!


Brokerage Fees

We mentioned in the last section that the fees CFD brokers charge tend to be about half what a traditional stock broker charges, but there’s some variance here, depending on exactly how you trade.

There are three basic ways you can do that:  Online, over the phone, or with a full-service brokerage firm that includes professional advice and assistance.  We’ll look at each of those three just below. 

For the moment, the most important points to remember is that brokerage fees are the most visible costs you’ll  have to bear as an investor, but they’re not the only ones, and that they tend to be significantly less when using a CFD Broker.


BACK TO PART 02 CONTENTS



On-Line-Trading

This is far and away the simplest and easiest way to trade.  It’s super convenient, and there are some really great online brokerage services that offer an amazingly robust set of features.

You can expect to pay between $7 to $12.50 per side, or 0.1%, whichever is greater, and you should be aware that most online brokers offer volume discounts.  That’s probably not going to matter to you right away, but once your turnover hits a million bucks a month, you’ll see your fees reduced further still.

If a million dollars a month sounds like a lot of money to you, consider this:  If you make 10 trades (both sides) at $50,000 each, you’re done, which means you can hit that volume a lot quicker than you might think!



Over the Phone Trading

The internet has existed longer than CFDs have, so this is kind of a holdover, imported by CFD brokers because it was the way stocks were traded before there was an internet.  It’s a little old school, but it’s the method some people simply prefer to do business.

Your fees will be a bit higher if you choose to trade in this manner, ranging from $12.50 to $35 per side, or 0.125% to 0.35%, depending on how complex your order is. 

Note that you can find some brokers who will accept phone orders at no extra charge, but this is becoming increasingly rare.  Most brokers encourage their clients to place orders online, and the extra fees are an important part of that.



Full Service Firms 

Full-Service brokerage firms have been around almost as long as the stock market itself.  They are high-end service offerings that involve lots of hand holding and professional advice, but of course, they’re also the most expensive way you can trade, charging as much as 1% per side.

Think about that for a second.  If you use the least expensive, online trading option, then compared to that, the full-service broker is ten times more expensive.  Unless the professional advice you’re getting provides returns ten times better than you can get on your own, you’re not getting a great deal.

In practice, this would be quite rare, and because of that, you’re almost always better off to do your own research and reap bigger profits as a result.


Beware Of Promises About Commission Free Trading!

There are a number of brokers who promise commission free trading, and with good reason.  It is an irresistible lure.  Unfortunately, if something sounds too good to be true, then it almost always is.

Mostly, this is used as a marketing gimmick.  The reality is that commission free brokers simply raise their costs in other areas in order to make up the difference.  In this case, the most common approach is to increase the spread you have to pay.  So for instance, if a broker normally charges a 5 cent spread, then a commission free broker might use an 8 to 10 cent spread.

Don’t take these numbers as gospel.  We’re only using them as examples.  You’ll need to research specific brokers to get a feel for their cost structures.


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Paying the Spread

While we’re on the topic of the spread, this is a good time to acknowledge it as a very real cost you’re going to have to pay.

A bit earlier, we made mention of the fact that CFDs were ill-suited investments to make if you want to capture micro-profits, holding positions for a very short timeframe (measured in minutes or hours).  The reason for this is the fact that you have to pay the spread.

Here's an example of how that works:

Let’s say you’re buying a Share CFD for a company, priced at $50.  The price you pay might be $51.  The difference is the spread.

Let’s say you bought 50 shares.  If you turned around and sold them as soon as you completed your purchase, you’d lose fifty bucks, because you’d be selling at $50, but you bought at $51.  In other words, the stock price needs to rise by at least a dollar in order for you to break even. 

Anything after that, less the selling commission, is money in your pocket, but as you can see, the spread can really impact your bottom line and is something you should always be mindful of when conducting trades.


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CFD Financing

Most investors use CFDs for day trading, but you can hold your positions as long as you like.  If you hold them past 5pm New York time (7am Australian Eastern Time), then you’ll most often be charged a small financing charge for maintaining your position overnight.

Having the option to do this gives you more investment opportunities, but again, this is not something you should do lightly.  So how much are we talking about here?

The exact rates vary from one broker to the next, and you’ll want to carefully read your broker’s PDS (Product Disclosure Statement) to understand the full cost, but in general, brokers charge 2-3 percent above the cash rate.

So for instance, if you’re trading in Australia, and have taken a $5000 position, and the Reserve Bank of Australia’s rate is 3%, and your broker charges 2% above that, then you’re looking at a charge of:

·       Position size ($5000) * (RBA Rate (0.03) + broker’s fee (0.02) = $250

·       Divide this number by 365 to get the one day rate = $0.69

As you can see, this is a very modest fee, and it’s not something that should dissuade you from holding a position for longer than one business day.

Having said that, you should only do so if you are extremely confident that the price will continue to rise the following day (long position).

Again, this fee is small enough that it should not often dissuade you, but you do need to be mindful of the fee, because it’s part of the cost of doing business, and will have some impact on your final Return on Investment.

Here’s something interesting:  It works in reverse if you’re holding a short position!  In other words, instead of being charged a small fee, you get a small credit if you’re holding a short position.  The same math applies.

Note:  Markets aren’t open on the weekend, so if you hold your position over the weekend, then you’ll be charged (or credited) for Saturday and Sunday as well.


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Foreign Currency Exposure

A lot of people get addicted to the fast pace and extreme volatility of the currency (forex) markets, but there is a small wrinkle you should be aware of that a lot of people overlook.

Most brokers hold your profits in US Dollars.  That’s true regardless of what currency pair you’re trading (even if you’re trading Crosses, which don’t involve US Dollars on either side). 

What that means from a practical standpoint is that your country’s exchange rate as compared to the US Dollar matters a great deal, and can impact your total Return on Investment.


How Corporate Actions Affect You

Corporations are always in motion.  Always busy, and their actions can impact your trading positions in a variety of ways.

We’ll go over some of the basic things you can expect to see happening as you begin investing.  Some of these will serve to enhance your positions and their profitability, while others will have to be counted as expenses against you.


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What about Dividends?

At first glance, you might not think that dividends will play any role in your CFD trades.  After all, you’re trading a derivative, not the actual shares of stock.  The reality though, is that they can, and do have an impact on your CFD positions.

A dividend is essentially a reward paid to investors for the profits that the company has paid.  They are paid twice a year, with the first annual payment being referred to as the “interim dividend,” and the second being called the “final dividend.”

From the perspective of a CFD investor, the most important date to remember is the “ex-dividend” date, often called the Ex-Div date for short.  If you buy before this date, and are still holding it when the dividend date rolls around, you’re entitled to a dividend if one is paid.  If you buy after the Ex-Div date, you’re not.  It’s as simple as that.

When the dividend is paid varies from one broker to the next, but in general, the payment will be made either the day before the ex-div date, or the day of.

Important Note!  If you’re holding a short position, then you don’t get a dividend.  Instead, your account will be debited by the dividend amount. 

For instance, if you hold a short position of 1000 share CFDs on a given company, and that company pays a ten-cent dividend, then you’re going to see a hundred bucks debited from your account on the day the dividend is paid.  This is the kind of thing that can (and should) influence your buying and selling, short/long position strategy!

It’s also important to mention that in the overwhelming majority of cases, a company’s share price will fall by an amount equal to the dividend payment when it occurs.  In rare cases, this doesn’t happen, but it happens often enough that you can rely on it.

Yet another point is the fact that actual shareholders receive Franking credits, which are tax credits for the taxes the company has paid on its profits before the dividend is paid.  CFD investors do NOT get these credits, which does have some tax implications at the end of the year, but certainly shouldn’t often dissuade you from holding a given position.

What About Index CFDs and Dividends?

This is yet another dividend-related wrinkle.

If you’re holding an Index CFD position, and one or more of the companies that make up the index pay a dividend, then your account will be credited or debited, based on the company’s position contributes to the index in question.

This seldom makes a huge difference, but can either be a nasty surprise or an unexpected boon, depending on the shape of your position (short or long). 

Say, for instance, you’re holding a short Index CFD position and are anticipating a nice profit, but you failed to take the dividend payments into account.  This can easily wipe out any profits you were expecting!

The reason for all of this is simply that because CFDs are priced according to the underlying asset, anything the corporation does has to be reflected in the CFD market, or the pricing picture would become skewed over time and not track perfectly, like it’s supposed to.


What about Stock Splits

Once in a while, a company will implement a stock split.  If you’re holding 10,000 shares of that company’s stock at a $100 share price, then after the split, you’ll be holding 20,000 shares at $50.

When this happens, it will be reflected in the CFD market as well.  Again, any action the corporation takes is reflected in the CFD market.  If that weren’t so, then the pricing would not, and could not be accurately reflected.


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What if a Company Goes Bankrupt

It’s a sad fact, but corporations often do go bankrupt.  Here’s the thing though; that never happens overnight.  There are signs and forewarnings, and if you’re paying attention, you can see it coming well in advance.

If you’re holding a long position in such a company, then as the stock price continues to deteriorate, it will inevitably trigger your exit strategy and you’ll mitigate your losses before they become catastrophic, but there’s another way of looking at it.

A company that’s swirling the drain represents a profit opportunity in the form of taking short positions – provided that you exit the position before the bankruptcy is finalized.

Note that everyone else (your broker included) is going to see the bankruptcy coming, and when a company is in distress, the rules for investing begin to change.  You may be required to put up up to a 100% margin on your position, and close the position out at the last available trade price as determined by your broker.

This is a key point.  In certain exceptional cases like these, your broker can and will change the normal rules of trading as they deem appropriate.  This isn’t done as a means of punishing you, but to keep the market functioning smoothly.  Sometimes it works in your favor, and sometimes it doesn’t, so don’t take it personally.


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The Tax Implications of CFDs

There are a couple of important points here.

For the purposes of this section, we’re going to assume you’re living in Australia.  If you live in some other country, you’ll want to study that nation’s tax code carefully, and it might be best to get the help of a professional tax preparer for at least your first year, so you can get an in-depth look at how your investing profits and losses impact your tax situation.

The first point worth mentioning is this:  Profits and losses are treated differently if you’re running your investment portfolio as a business, versus if you’re making trades as a form of gambling.

This goes back to something we talked about earlier, and our recommendation is that from day one, you treat your investment enterprise as a business, because of the discipline it helps instill in you.

From a tax perspective, the difference is this:  If you’re treating your enterprise as a business, then your losses will count as an allowable deduction.  If you’re not, they won’t.


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Part 02: Key Points To Remember

  1. Your investment costs really matter.  Keeping them low will help improve your ROI (Return on Investment).  Also, having a firm understanding of your costs is key to your long-term success because it keeps you from paying for crap you don’t need, or paying too much for services in general
  2. Corporate actions can and will have an impact on your CFD positions.  It pays to be aware of them.  This comes down to doing your due diligence, and understanding the companies or products you’re investing in
  3. If you’re investing in CFDs, then the major costs you should be aware of are:
    + Brokerage fees
    + Paying the spread
    + Paying Dividends(or having them credited to your account, depending on what kind of position you’re holding)
    + CFD Finance (if you’re holding a position overnight)
  4. It pays to consult a tax professional for at least your first year of investing so you can learn how to properly handle your profits and losses from a tax perspective
  5. We recommend running your investment portfolio like a business from day one.  Not only can you count any losses you incur as an allowable deduction, but it also helps to foster greater investing discipline.

BACK TO PART 02 CONTENTS

 

 


PART 03: GETTING STARTED INVESTING IN CFDS

 

Direct Market Access CFDs
   Advantages of DMA CFDs
   Disadvantages of DMA CFDs
 Market-Maker CFDs
   Advantages of Market Maker CFDs.
   Disadvantages of Market Maker CFDs
DMA Vs. Market Maker – Which One Is Right For You?
Finding The Right Broker
Questions t o Ask Of A Potential Broker
Opening An Account
Types Of Accounts
   Individual Account
   Joint Account
   Company Account
   Trust Account or SMSF
   Limited Risk Account
Funding Your Account
Self-Assessment – Which CFD Market Is The Best Fit For You?
Before You Make Your First Trade
Defining A Basic Investment Strategy
   Market Entry Criterion
   Your Money Management Plan
   Understanding The Risk vs. Reward Tradeoff
   Your Exit Criterion – Know When To Hold ‘em, Know When To Fold ‘em
Fine Tuning Your Strategy
   Controlling Leverage
  Tools Of The Trade
Part 03 – Key Points To Remember

 

Everything to this point has been background information so you’ve got a clear picture of what you’re getting into, should you decide to invest in CFDs.  In this chapter, we’ll be talking about getting your account set up and preparing you to make your first trade.

If, after having read everything to this point, you’re on board with the idea and have decided that CFDs are for you, then this section will tell you everything you need to know to get started.  Ready?  Let’s do this!

 

 

Direct Market Access CFDs

This is the first of two basic kinds of market access you can get, depending on the broker you choose to work with.  DMA CFDs offer a number of compelling advantages that you might find too strong to ignore.  Having said that, there are some shortcomings too, but don’t worry, we’ll go over the pros and cons, just below.

Advantages of DMA CFDs

  • Complete Transparency -  This is the biggest single advantage of DMA CFDs.  The reason you get such good transparency is the fact that your orders are placed directly into the underlying market.  In other words, you’re cutting out the middle man, and plugging your orders directly into the ASX (the Australian stock market), or the market of whatever country you’re trading in, if you’re not in Australia.  Your orders are replicated exactly as you place them by your broker.
    When you place orders, you can view your trades in the market depth, so you know exactly where your orders sit at literally any point in time, and that’s a huge advantage.
  • No Requotes – The best way to describe this is to tell you what it doesn’t mean.  Sometimes, you place an order to buy a share CFD at, say, $30, but when you put the order in, your broker comes back and tell you that no shares are available at that price, and quote you another rate, say, $50.25.  That sucks, and it can hurt your profits and limit your opportunities.
    Fortunately, that never happens in the DMA CFD world, because of the aforementioned transparency.
  • Pre-Market Auction – Since your orders are going straight into the underlying market, the DMA CFD model also gives you the opportunity to participate in the pre-market auction, which opens up opportunities you normally wouldn’t have access to.
    Note that the Australian market staggers its starting time alphabetically, according to the following schedule:

Shares Beginning With

Opening Bell

A-B

10:00:00

C-F

10:02:15

G-M

10:04:30

N-R

10:06:45

S-Z

10:09:00

**Note:  All start times are +/- fifteen seconds

  • It should also be noted that the Australian market temporarily halts trading around 4pm and allows all participants one final opportunity to buy or sell in a closing auction.
  • Increased efficiency – one of the side effects of your orders being placed directly into the underlying market is speed.  There’s no middle man, so there’s no time lost.  While it’s true that CFDs are not great investments for capturing micro-profits and holding positions for mere minutes, it’s also true that speedy execution of trades can be a compelling advantage that can often increase your profits. 
  • Ability To “Improve The Quote” – This is (or can be) another compelling advantage.  You can improve the current bid or offer by placing limit orders within the current spread.  So for instance, if the current bid/offer is $50.00/$50.18, then you can place your orders within that range and gain a tactical advantage by essentially moving you to the head of the line.

Disadvantages of DMS CFDs

Clearly then, DMA CFDs offer some pretty compelling advantages, but it’s not pure upside.  There are some disadvantages too, and you should be aware of them.  They include:

  • A Somewhat Limited Range Of Opportunities – Data feeds that link brokers to international markets are expensive.  Because of that, DMA CFD brokers don’t typically offer as much in the way of exposure to global markets, which can limit your opportunities
  • Higher Platform Charges and Expenses – Because DMA CFD brokers use prices that come direct from the underlying exchange, you get better visibility and more complete, real-time data…at a cost.  The added cost can be worth it, provided you’ve got the skills to make good use of it
  • Higher Trading Costs – Because DMA CFD brokers are hedging your orders directly into the underlying market, they incur market-based fees, which are reflected in higher brokerage costs.


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Market-Maker CFDs

A CFD market maker “makes the market” on a whole range of products on several markets, worldwide.  They have the ability to set their own price, but not with perfect freedom.  The price still reflects (somewhat imperfectly) the price of the underlying asset.

Here are the major advantages of using this type of broker:

Advantages of Market Maker CFDs

  • A global range of options – You get broad, truly global market access when you use this type of broker, which gives you trading options you’d otherwise be shut out of entirely.  Consider this to be one-stop shopping.  From a single control panel, you have access to a world of opportunity!
  • Super Easy To Use – Simplicity is one of the hallmarks of Market Maker CFD brokerage systems.  You get an intuitive interface, making it easy to buy, sell, and track your trades.
  • Extras! – The two biggest extras you get here are free charting, allowing you to get (and keep) a bird’s eye view on all your positions, and access to software to help you do research and enhance your trading strategy.  Note that some brokers charge a nominal fee for accessing local charts and data.  These charges are most often reimbursed after a certain monthly trading quota is met, but this varies from one broker to the next, so you’ll want to read the terms and conditions closely so you’ve got a good understanding of the fee structure.
  • Low margins – this is huge, but as we’ve mentioned before, it can be a bit of a two-edged sword.  Leverage can help dramatically improve your ROI, but it can also come back to bite you if you don’t use it well and correctly.

Disadvantages of Market Maker CFDs

There’s really only one disadvantage to talk about here, and it can be a pretty important one.  Trades are executed more slowly because you’re essentially dealing with a middle man, and you don’t have as much transparency or depth of information because the pricing isn’t perfectly reflective of the underlying market.

DMA Vs. Market Maker – Which One Is Right For You?

Ultimately, working out which of these is right for you comes down to what you’re looking for in a broker.  To answer that question, you’re going to need to ask yourself some hard questions, and get honest answers back.

If you value convenience, ease of use, and global reach, then a Market Maker CFD broker is going to be a natural fit for you.  This is also true if your interests run to international Index CFDs commodities and forex.

On the other hand, if you’re only trading in your local market, then you have to really ask yourself if the added advantages offered by a Market Maker broker are going to be things you’ll make regular use of.  If not, then you have your answer!

Note:  If you’re wondering what the prevailing trends are, according to a recent Investment Trends survey, 47% of respondents indicated that they preferred the DMA model, while 14% said they preferred the Market Maker model.  Which one will you prefer?  Only time will tell!

Then again, there’s a third option.  Why not have your cake and eat it too?  After all, most CFD brokers, regardless of type, only ask for a starting balance of $1000 or so, which means that it should pose no special challenge to open both types of accounts and try them out to see which one you like better. 

It won’t take many trades on each system to get a good feel for where your preferences lie.


 

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Finding the Right Broker

This is both more complicated, and much simpler than it first seems.  The simple truth is that there are a lot of brokers to choose from.  It’s a pretty crowded market place, and because of that, a lot of brokers use freebies and giveaways to lure you into choosing them. 

This helps you in two ways:  First, you’ll get lots of great extras and incentives, which is always nice, but there’s a much more straightforward benefit.  More competition means lower rates as brokers cut their prices (and profits) to the bone to stay competitive, and that helps your bottom line.

One thing you should be aware of is that while your choice of broker is important and definitely matters, it’s not something that will make or break your trading career.  If you find that your first pick isn’t everything you had hoped it would be, it’s a fairly simple matter to move on to some other broker that meshes better with your needs and trading style.

Another point here is that over time, your needs are going to evolve and change, so the first broker you select may not be the one you stay with in the long run, and that’s okay.  When you’re first starting out, you don’t really have the tools and experience you need to pick the “perfect” broker for you, so your primary goal should be to find one with low commissions and a simple interface that makes it easy for you to get started.

As you gain more experience, you’ll start to get a better feel for what you need, and can begin comparing other brokers with the one you started out with to see if there might be a better fit somewhere out there.


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Questions To Ask Of A Potential Broker

Once you’ve gained some trading experience, you’ll have a much better sense of what you’re looking for in your “perfect broker.”  Once you have that experience under your belt, the following pointed questions will help you narrow the field and ultimately make a good decision on that front.  Bear in mind that you may find that the broker you initially decided to go with is the one you decide to stay with.  It happens, but if it doesn’t don’t be alarmed by that either.

One final thing to consider is your chosen broker’s position on hedging trades.

DMA CFD brokers automatically hedge every trade, which means that they adopt the opposite position in the market, but Market Maker brokers manage their own hedging strategy, based on their knowledge of their clients’ experience.

  • What are your fees, commissions and trading costs?
  • Is mobile trading allowed?
  • Do they provide DMA or Market Maker CFDs?
  • How many markets can be accessed from the platform?
  • What’s the range of their products and markets?
  • What kind of software do they offer?
  • Do they have demo accounts available?
  • And most importantly – what kind of research tools are available?

This last one is probably the single most important question you can ask.  The ability to get eyes on detailed, timely research is huge, and can dramatically improve your ability to make winning trades, and thus, enhance your ROI.

While you’re on the topic of quality data to guide your decision-making process, it’s also worth asking about educational materials.

The quality of your chosen broker’s customer service and support is also critical, but that’s not something you can really ask your broker, because of course, according to just about everyone, their customer service is world-class.

No, to find that out, you’re going to either have to call in and see for yourself, or do some research and see what other people are saying about it.  If you do ask about it, the one thing you definitely want to hear is that 24-hour support is offered, either six or seven days a week.

Finally, and this isn’t a question really, but it’s something you’re going to want to do for every broker on your semi-finalist list:  You’re going to want to carefully read two documents:

  • The FSG (Financial Services Guide)
  • And the PDS (Product Disclosure Statement)

All brokers will have both of these documents, and make them readily available.  The first document describes the range of services offered by the broker in question, and gives you full details on how the company operates, including how they get paid and how they handle customer complaints.

The second document outlines what products they offer and any additional charges and fees that trading in those products may introduce to the equation.  You’ll also get full details on the risks and advantages of investing in specific products, and all the information you’ll need to determine whether or not a given investment opportunity is a good fit for you.


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Opening An Account

Opening an account is almost always a simple, straightforward process that will only take a few minutes of your time.  It’s simply a matter of creating a login, selecting the type of account you want to open, and verifying your identity.

Identity verification is usually as simple as providing a copy of a picture id like your driver’s license, though the exact requirements will vary slightly from one broker to the next.  Just follow their simple, step-by-step instructions and you’ll be done in no time!


Types Of Accounts

One of the first, important questions you’ll need to answer though, revolves around the type of account you want to open.  We’ll describe each of these in turn, just below.


Individual Account

These are the most common types of accounts, and are the easiest to open.  You’ll just need to read and agree to the terms spelled out in the FSG and PDS, and provide your identity verification (photo id – driver’s license, passport, etc.) and fund your account, which we’ll go into later.

Note that some brokers might require a certified copy of an original document for identification purposes, but this isn’t always the case.


Joint Account

Joint accounts are great if your goal is to open an account with a business partner.  In this case, both parties can execute trades and both can add or withdraw funds from the account.  In this case, the ID verification requirements apply to both users.


Company Account

Company accounts are a bit more complex to set up, and there are a few more hoops to jump through.

These accounts do share some traits with joint accounts, in the sense that all Directors much fill out the forms and prove their identity.  In addition to that though, you must prove the formal existence of the company itself, and name the parties who will be authorized to make trades and changes to the account, and to make a declaration of liability in the event that something goes wrong.


Trust Account or SMSF

Trust accounts are functionally similar to company accounts in that all trustees (if there are several) must fill out the forms and provide identification, with one trustee being named as the manager of the account, with that person being in full control over any and all decisions about what trades are made, and having the ability to add or withdraw funds.

As with the company account, the Trust itself must be proved to exist and be authentic.


Limited Risk Account

Not all brokers offer these, but a few still do.  These types of accounts offer some protection in the event of a worst-case scenario, and guarantee that you can’t lose more than your starting balance. 

This added security comes with certain restrictions and limitations though, and you won’t have access to the full range of CFDs the broker offers.


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Funding Your Account

Once you’ve created your account, selected the type that works best for you, and verified your identity, the next step is funding.

As with the account creation process, this is pretty simple and straightforward.  Most brokers give you three options here.  You can either fund via direct deposit, which involves linking an established bank account to your trading account, via credit card, or by way of BPAY. 

Depending on the broker you’ve selected, some fees may apply.  One of the more common promotions offered is that the broker will absorb those fees, even if they’re normally charged, so that’s something to keep an eye out for.

One question that often comes up, especially with new traders who are just starting out is “how safe is my money.”

We’ve mentioned that Australia has some pretty stringent rules on that front, so if you’re trading here, then you can do so with a high confidence level that your money is quite safe.

This is because most brokers keep the funds of their investors in Trust Account that’s separate from the rest of the broker’s business accounts.  That firewall keeps the money safe, even in the event that the broker’s firm goes bankrupt.


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Self-Assessment – Which CFD Market Is The Best Fit For You?

This is a totally separate question from the DMA vs. Market Maker question, and has more to do with the types of opportunities you’ll be most interested in trading in, once your account is up and running, and there’s a lot more to this than first meets the eye.

One of the key things that will guide your thinking here are the markets and types of investments you already have experience in dealing with.

This is simply a case of using what you know.  If you’ve got a good background in tech companies, for instance, and you have a firm understanding of one in particular, then use that.  You’ll save time and be able to start making trades that much more quickly, without having to do a ton of research.

Another important consideration is what your personal trading window is.  If you have an office job, working 9-5, and you live in Australia, then it’s going to be hard for you to make trades during the day on the AUX, so international markets will have more appeal, because you can conduct trades when you get home in the evenings.

Yet another important consideration is your tolerance for risk.  If you are fairly risk averse, then you’ll want to trade in low-volatility markets, but of course, that comes with certain tradeoffs too, not the least of which is the fact that your potential for profits will be somewhat lower.

The simplest way to get a handle on market volatility is to look at the ATR, which stands for “Average True Range.”  This is a simple indicator that gives you a good top-level view of how volatile any given market is over time. 

Reaching a good understanding of your risk-tolerance is an essential component to successful investing, and will go a long way toward helping you achieve long term success.  It will also allow you to make a fairly realistic prediction about what kind of return you can expect, although we’ll have more to say on that topic in a later section.


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Before You Make Your First Trade

We’re still not done yet, and you’re still not quite ready to jump in and start trading.  We’ve gotten a lot of the groundwork covered, but the last thing you want to do is go off half-cocked, and that’s what this next section seeks to prevent.

We’ve mentioned a couple of times that our recommendation is that from day one, you should treat your investment portfolio like a business, and we’ve outlined the main reasons that’s so important.  Now, we’re going to tell you how to go about doing that.

The very first thing you’ll want to do is to write up a formal business plan.  This will help you answer some key questions like why are you investing in the first place?

To make a profit, sure, but beyond that, what’s the point?  What goal are you trying to achieve?  Are you building a retirement nest egg?  Putting together money for your dream house?  What?

Ultimately, this comes down to being a variant of the “what do you want to be or do when you grow up?” type question.  It’s important, because understanding what your aims and goals are is an essential component to defining your overall investment strategy, and speaking of that, that’s where our guide is headed next!


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Defining a Basic Investment Strategy

Your investment strategy has several moving parts, but the “Big Three” are:

  • Your Goals
  • Your Expectations (ROI)
  • And Your Tolerance for Risk

Only by having a thorough understanding of these three components can you begin to devise a workable investment strategy for yourself.  That matters because investing without a plan is a recipe for disaster.

If you go in without a plan, then you’ll be inclined to shoot from the hip, make decisions sans research, and allow your emotions to take over.  That never ends well, and given that, the next question then, becomes “how, precisely, do you construct a viable strategy?”  To do that, you need to work out some trading particulars, which include:

 

Market Entry Criterion

Whole books can and have been written about timing your entry into any given market.  You’ll find lots of different opinions on the subject, and lots of different strategies to inform you of when it’s the “right” time to enter into a position.

At the end of the day though, all those strategies have one thing in common.  They all rely on one or more measures to inform the decision, which takes emotion and guesswork out of the equation.

The purpose of all this focus on finding the proper time to enter the market is to build expectancy into your system.  That’s something we’ll explain in more detail later. 

For now, the important thing to understand is that while perfecting your market entry strategies are important, don’t sweat it if you don’t do it perfectly.  It’s not going to kill you, but refining your technique is something that will help ensure profitability as you gain more experience.

Ultimately, your goal should be to develop a viable market entry strategy for the following three market types:

  •  Range Bound
  • Trending
  • And Volatile Breakouts

These three cover all possible trading conditions.

You’re bound to get lots of advice on the subject of entering each of these types of markets, but for now, let’s just keep it simple.  Use the following indicators to build your strategy around:

  • For Trending Markets, use moving average indicators to inform your decision
  • For Range-Bound Markets, use oscillators like Bollinger Bands, RSI, or Stochastics to inform your decision
  • For Volatile Breakout Markets, use chart pattern analysis

 

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Your Money Management Plan

If you want to achieve any level of success in the market, then you’re going to need to learn to manage your risk.  That means managing your money and making sure that you’re not putting all of your investment eggs into one basket so as to prevent a catastrophic loss.

The question is, how?  How precisely do you do that?

Fortunately, there’s a really simple answer.  It’s called “Fixed Percentage Risk Per Trade.”

This is a formulaic approach that tells you how large any given position should be (how many CFDs you should buy).  In order to make the calculation, there are a few basic pieces of information you need.  These are:

  • Your entry price
  • Your initial stop-loss
  •  How much capital you’ve got in your account
  • The percentage of capital you opt to risk on any position (let’s just arbitrarily say you settle on 2%) – a good rule of thumb is to never risk more than 1-2% of your capital, so use whichever makes the most sense to you

Here’s how you use the formula:

Let’s say you’ve got $25,000 in your account.  You’ve entered a position at $20.00, and your initial stop loss is $19.50 (fifty-cents away).

  • 2% of your capital is $500 ($25,000 * 0.02)
  • $500/ $0.50 = 1000 share CFDs

That’s useful as far as it goes, but this formula will also tell you when (or if) you should increase your position size, or reduce it.

 

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Understanding The Risk vs. Reward Tradeoff

The higher the risk, the greater the (potential) rewards.  That’s it in a nutshell, and it’s a concept that most people understand intuitively.

It really matters in terms of devising a successful trading strategy though, and the first thing you need to do is to have an honest conversation with yourself about how much risk you can tolerate.

If your risk threshold is low, then you’ll take a pass on high risk opportunities that could have big payoffs, or could lead to catastrophic losses.

On the other hand, if you have a relatively high tolerance for risk, you’ll be much more inclined to take those trades, which will open the door to more trading opportunities, but require much better risk management skills to be successful.

Each person’s tolerance for risk is different, which is why it’s so crucial to understand where the line is for you.

Looking at the risk-reward ratio in conjunction with your winning trades percentage gives you a valuable measure that enables you to accurately assess your trading performance.

Your risk-reward ratio is calculated as follows:

(Average Win Amount/Average Loss Amount)

This gives you a snapshot of how much money you make when you exit a trade profitably, versus how much you lose when you misstep.

Obviously, the higher the risk-reward ratio, the better your profits, but that’s only true if your win percentage is high enough to make it pay off.  If you’re mostly conducting losing trades, then the system can still lose money.

The best way to think about this is to consider the lottery.

If a ticket costs you $1, and you stand to win $10 million, then you’ve got a HUGE risk-reward ratio.  On the flip side though, the win percentage in such a scenario is incredibly low, which explains why almost nobody makes money playing the lotto!


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Your Exit Criterion
– Know When To Hold ‘em, Know When To Fold ‘em

While the absence of a clearly defined entry strategy won’t necessarily make or break your portfolio, the absence of a clearly defined exit strategy will kill you faster than anything.  Worse, defining a cogent exit strategy is one of the hardest elements of successful trading to master.

Think about it.  You’ve entered a position and have seen it increase in value.  When, exactly do you sell?  If you sell too soon, sure, you’ll lock in profits, but if the value of the position keeps rising, you’ll essentially leave money on the table.

Or think about the flip side:  You enter a position and it starts to lose money.  How big a loss are you willing to withstand before you bow out?

Being able to answer those questions definitively is crucial to your long-term success, because if you fail to properly define your exit and start losing money, you’ll damage your confidence, which will hurt your chances of success in all future trades.

This then, describes the two parts you’ll need in order to properly define your exit strategy:

  • How and when to exit when taking profits
  • And how to exit at a loss

Without both of those things, you can’t expect success in the long run.

The key here is the concept of expectancy.  Expectancy comes in two flavors:  Positive and negative.  This simply describes setting the conditions of all your trades so that the odds are ever in your favor. 

Note that this isn’t the same thing as trying to devise a system that increases your percentage of profitable trades.  Its main purpose is to ensure that you win consistently by ensuring that your successful trades are vastly more profitable than your losing trades lose.

Here’s how you calculate expectancy:

(Percentage of Winning Trades * Average Win Amount) – (Percentage of Losing Trades * Average Loss Amount)

This will tell you whether your trading strategy is a positive expectancy system, or a negative expectancy system.  Obviously, if you’re trading in a negative expectancy system, then you need to change that immediately, or you’re doomed.

Don’t let this discourage you though!  Knowing is half the battle, and once you know, you can start taking steps to get your trades back on track.


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Fine Tuning Your Strategy

Obviously, you’ll be in a better position to fine-tune your strategy after making your first few trades, so we’ll have much more to say about this in later sections, but there are some additional things you can feather into your thinking before you start that will serve to modify your basic strategy.


Controlling Leverage

Historically, the stock market earns investors an annual return of about 11%, totally unleveraged.  If you’re trading CFDs at 2x leverage, and meeting the industry average, then you can realistically expect to earn about a 22% return.  If you’re trading at 3x leverage, then on average, you can expect a 33% return.

Having said that, we’ve talked before about the potential dangers of leverage.  If you’re not careful, and you find yourself on a losing streak, then your losses will be proportionally magnified based on the amount of leverage you’re using.  This is why we recommend starting slow and cautiously.

From Day One, you’ve got to have a firm understanding of exactly how leveraged your positions are, so you can better control your risk.  This is not something anyone is going to tell you, or do for you.  Just because you can trade with only a 5% margin doesn’t mean that you should!

Ultimately, the decision about how much leverage you use is on you.  Use it with care and caution.

So how do you know exactly how much leverage you’re using?

It’s easier than you might think.  Here’s the formula:

(Total Exposure/The Size Of Your Account)

To put some real numbers to this, if you’ve got $5k in your account, and you’re controlling $20k worth of CFDs, then your leverage is (20,000/5000) = 4x.

The next logical question then, is that good?  Is that bad?  How do you know?

While the answer differs for everyone, here are some basic rules of thumb:

  • New traders who are first starting out should aim to keep their leverage at or near 1.0
  • After 3-4 months of trading, and once you’ve gained some familiarity with using stop losses, aim to keep your leverage between 2.0 and 3.0
  • Once you’ve got some experience under your belt, and have been trading for about a year, are familiar with stop loss strategies, risk management techniques and understand your strengths and weaknesses as a trader, aim to keep your leverage around 5.0
  • If you consider yourself to be a professional trader, aim to keep your leverage between 7.0 and 10.0

Any more than that, and you’re flirting with disaster.

Now, having said all that, what are your investment goals?  Are you aiming to make a 20% annual return on your investment?

If so, and given that the stock market offers an annual rate of return of about 11% unleveraged, then you can meet your investment goals with just 2x leverage.

That’s the kind of thinking you need to be engaged in.  Only by having a clear understanding of your aims and goals can you properly control leverage and use it for maximum benefit without getting carried away.

If you don’t take anything else away from this section, remember this:  Regardless of what your investing aims and goals are, your first, overriding priority is to stay in the game.  After all, you can’t achieve your goals if you’re not even playing, and if you don’t keep a good handle on your leverage, you can easily wipe out the entire value of the account.

To make sure that doesn’t happen, you’ve got to stay in the game, and that means being very careful with leverage, over and above anything else!


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Tools Of The Trade

In order to make successful investment decisions, you need two things:  Software and data.  The problem is that raw data in isolation isn’t very useful.  There’s so much of it that it can be hard to pull anything meaningful out of it.

Software helps turn raw data into actionable investment intelligence.

Fortunately, most brokers do an excellent job at providing free charting software that can turn those oceans of raw data into intelligence you can use. 

Most of the free charting software offered by brokers is quite good, and is more than enough to get you started.  Sooner or later though, you’re going to want more than the simple charting software can provide, and when that day comes, here are some other programs to consider:

  • AmiBroker – An excellent versatile tool that gives you the ability to build your own indicators using a simplified coding language, and provides full-featured back-testing capabilities as well as excellent EOD (End of Day) data.
  • Incredible Charts – a low-cost options that has lots of great charting features and data services.  If you’re just starting out and looking for something a bit more robust than what your broker is providing, this one’s a great option
  • MetaStock – With more than a decade of experience and hundreds of thousands of users, this is one of the most popular trading platforms available.  Owned by the Reuters Corporation, it’s simply amazing, and you’ll be dazzled by its broad range of features
  • Ninja Trader – One of the best options out there, once you’ve gained some experience at trading.  One of the coolest aspects of it is that it gives you the ability to “replay” your trades and consider alternatives to the actions you took.  This helps improve your skills in a big hurry, and as such, is an invaluable addition to the program.
  • TradeStation – one of the oldest software packages out there, and often cited by professionals.  It gives you the ability to create your own indicators and build out your trading strategy online.  Great stuff!
  • Wealth Lab Pro – This platform was acquired by Fidelity Investments, which is a powerhouse in the world of investing, and as such, the platform is highly regarded and well-trusted.  A little more expensive, but well worth considering!


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THE IMPORTANCE OF DATA    Data drives every aspect of your investing decisions.  If it’s not, it should be.  The last thing you want to do is to make decisions based on gut feelings or emotion.  Keeping everything data driven is the best way to avoid letting your emotions cloud your thinking.

 

Where data is concerned, you’ve basically got three flavors to choose from, and we’ll describe each in brief, just below:

  • End of Day (EOD) data – This is simply data downloaded at the end of each trading day that reports the open, high, low, close, and trading volume of all charts.
  • Real-Time Data – This is hands-down the most expensive data you can incorporate into your (paid) trading platforms, but there’s a wrinkle.  Your broker will almost always provide live-streaming data on commodity, index, and forex markets, but the drawback is that you can’t export that to any third-party software you might be using.  To get it there, you’ll need to pay for a data subscription
  • Snapshot Data – This is simply data you can download at various times during the trading day.  For instance, you can set up your system to download data on an hourly basis, so you can scan it and identify additional trading opportunities

In terms of where to get your data, there are a number of brokers available, and they wouldn’t still be in business if they didn’t offer a quality product.  To keep things simple, our recommendation is www.justdata.com.au  Simple, accurate, and reliable.  What could be better?


EVALUATING SOFTWARE    Whatever software you work with, here are some key ingredients a good program will have.  Note, don’t be alarmed if the software you’re using doesn’t offer all of these, but as you gain more experience trading, keep this list handy, because it may guide you to a program that meets your needs better.  Here’s the list:

  • Accurate and complete, fully adjusted market data
  • Some kind of ability to scan for specific criteria.  For instance, an ability to show any shares making a new 20-day or 30-day high
  • An ability to build your own indicators, which allows you to really customize your strategy
  • Some back-testing ability that allows you to fault-test your trading strategy

And now you’re ready to trade, which brings this section to a close.  We’ll pick things up in the next section with making your first trade and beginning to put your strategy into action!


YOUR INTERNET CONNECTION    For some people, especially day traders who only hold their positions for a matter of minutes (or sometimes, even less), the faster your internet connection, the better, because the added speed allows you to execute trades more quickly and efficiently, and maximizes the number of opportunities you can take advantage of.

CFDs aren’t really designed to be used for that kind of trading (because you have to pay the spread, which negates small-move profits in almost all cases), and for that reason, while a fast internet connection matters, what matters more is simple reliability.

All that to say that when you’re designing your trading system and setting up your computer, you should probably opt for an internet provider that offers rock-solid reliability and is very responsive should your connection fail for some reason.  Of course, get the fastest connection you can afford, but focus on the reliability.  The first time something goes wrong, you’ll be very glad you did!


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Part 03 - Key Points to Remember

  1. Direct Market Access (DMA) CFDs are great because of their transparency.  Your orders are directed straight into the underlying market
  2. Market Maker CFDs are great because of their convenience.  Its one-stop shopping in several markets all over the world.  Pricing largely replicates the pricing of the underlying assets
  3. Asking the “right” questions can cut to the chase and help you zero in on the right broker for you
  4. Opening and funding your account is pretty simple, although there is some paperwork involved, and you’ll need to comply with some basic background checks and identity verification.  Funding can be handled via direct transfer, credit card, or BPay
  5. Australia has stringent requirements of brokers where funds held on deposit are concerned, so your funds will be quite safe.  If you’re trading in some other country, you’ll want to do your due diligence so you know your risks and potential exposure.
  6. Having both a business plan and a well-thought out trading plan is essential to your long-term success
  7. Only trade positive expectancy trading systems
  8. Know yourself.  Know what your investing goals are, as these will help you develop, then refine your system
  9. Controlling leverage is an essential component of managing your risk – remember:  Above all else, your goal is to stay in the game.  That means keeping a tight rein on leverage and knowing  how much you’re using at any point in time
  10. Work smarter, not harder.  Use tools and technology to help you refine your strategy

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PART 04: WHERE THE RUBBER MEETS THE ROAD – YOUR FIRST TRADE

 

The Value Of A Demo Account
Differences To Be Aware Of – Live Demo vs. Actual Trading
What Kinds Of Orders Can You Place?
  Market Orders
  Limit Orders
  Stop Orders
  OCO Orders
 If Done Orders
What The Heck Is a Requote, Anyway?
Part 04 – Key Points To Remember 

 

At long last, you’re ready to start trading! You’ve got a basic system in place, and all the prep work has been done. You’ve found a broker you feel is a good fit, your account is funded, and you’re ready to begin. Now what?

 

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The Value Of A Demo Account

Almost all brokers these days offer a free demo account, and you owe it to yourself to spend some time playing with it to master the basic operation of the platform. There are no hard and fast rules here, but our advice would be to simply keep using it until you’re comfortable navigating through the system and can quickly and easily find every piece of information you need in order to conduct trades.
Your chief goal is to master the following basic operations:

  • View a Chart
  • Place a Market Order
  • Place a Stop Order
  • Locate Your Trading Instruments
  • View The Market Depth
  • Save Your Layout

Once you’ve done that, you’ve pretty well reached the outer limits of what the demo can teach you, and you’re ready to make an actual trade.


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Differences To Be Aware Of – Live Demo vs. Actual Trading

While many, if not most demo accounts offer the ability to make “fake” trades to get a feel for it, these are of limited value. It’s just not the same. Until and unless you’ve got actual money on the line, you’re not going to get the kind of experience you need to be successful.

Our recommendation then is that after you’ve mastered the platform’s basic operation, it’s time to just jump in. Of course, do so with care, and make sure your initial trades are small, so that you’re only risking a tiny fraction of your account’s value, but the simple truth is that there’s just no substitute for real world experience, and there’s only one way you can get that. 

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What Kinds Of Orders Can You Place?

While the particulars of each broker’s system will vary, one of the first things you’ll see is a place where you can execute different kinds of buy/sell orders. Broadly speaking, the kinds of orders you’ll be able to place are as follows:

  • Market Orders
  • Limit Orders
  • Stop Orders
  • OCO Orders
  • If Done Orders
  • Guaranteed Stop Loss Orders

We’ll take a closer look at each of those, right now.


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Market Orders

This is the most basic type of order you can execute. They give you the ability to buy or sell at the current market price, whatever it happens to be.
If you place a “buy” market order, then your broker will execute the trade from the first available seller at the lowest price possible, provided that the volume you’re buying is available. The inverse is also true. If you issue a sell order, then your broker will execute it, selling your CFDs to the first available buyer at the highest possible price, provided that the correct volume of CFDs is being requested by some other buyer.


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Limit Orders

This type of order allows you to buy at a lower level, or sell at a higher level than the current price. So for instance, if the current price of a CFD you’re interested in is $10, you could set an automatic buy order at some price lower than this (set by you), or, if you are currently interested in selling your CFDs and closing out your position, you can set a price that you would sell at that’s at some value higher than the current price (again, set by you).
When that price is met, the order will be executed automatically. This is excellent, but it brings to light a philosophic difference in trading, and a debate that has been raging for as long as markets have existed.
On the one hand, there’s a school of investment thought that says you should buy when the price is low and falling, on the thinking that you’ll get in at a good price, and stand to make money when it rises again.
The other, competing school of thought is that you want to enter the market just when the share price begins to rise, and ride the wave up, selling just as it crests to lock in your profits.
There are no “right” answers here, and both strategies can be used to make you money. Ultimately, it comes down to which school of thought is a better fit for your personal trading style.


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Stop Orders

Broadly speaking, there are two “types” of stop orders.
The first type is a stop to close out a long or short position, and this is probably the most important type of order you have at your disposal, because it’s the mechanism by which you mitigate losses.
Before you ever enter into any position, you should have a clear understanding about when you want to exit a trade if something goes sideways and you start losing money. That’s the price you use to define your stop order, and it will limit the amount of money you lose.
The second is a stop designed to open a new long or short position. This sub-type of the stop order is perfect for breakout traders who want to buy above the current price or sell short below the current price.
Breakout traders focus primarily on resistance. That is to say, if you’ve been studying a stock’s price for a while, and you notice that it often flirts with a given high, but never quite manages to hit it, it can be said that the stock encounters resistance at that price.
If something changes and it suddenly breaks out of that price boundary, then it’s a clear sign that the company has done something radical and different that has shifted the paradigm, which means opportunity for you.
That’s when you’d want to use a stop order to open a position. To take advantage of a company that has suddenly broken through a price barrier it has struggled to achieve, because it almost always means that big things are afoot for the company in question.

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OCO Orders

OCO, or “One Cancels The Other” orders are a great tool designed for people who can’t sit in front of their computers and watch the ebbs and flows of market activity all day long.
Here’s how you would use it:
Let’s say you’re currently holding a position of 5,000 CFD shares in a given company. You purchased them at $50. You know you’re not going to be in front of your computer, but you want to either lock in profits or mitigate losses, depending on how the market moves, so you issue an OCO, which says (for example):
I want to sell if the price hits $60, OR, if the price falls to $46. That way, whatever happens, if the price hits either of your target, that “side” of the order is executed, and the other “side” of the order is canceled out.

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If Done Orders

These are flexible orders that combine entry point and stop loss. So for instance, you establish a price you want to buy in at. Your order will only be executed IF the price hits your desired level, and if that does happen, then the stop order will automatically be executed, in the event that the stock price falls, thus limiting your losses.

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What The Heck Is a Requote, Anyway?

Trading is a very precise activity, and the numbers really matter. To give you a simple example, if you’re anxious to buy 5,000 shares of a given CFD at a set price, and that number of shares isn’t available, then you simply cannot conduct your trade at that price.
If you want the shares, you’re going to have to be willing to purchase at some higher price, which is a requote. This is something that happens every single day on the market. As the demand for a given company’s stock rises, so too does the price.
NOTE If you’re using a DMA (Direct Market Access) broker, then requotes aren’t available. You only find them in Market Maker systems. If you’re using a DMA CFD broker, then what you’ll find in their stead is a Volume Weighted Average Price (VWAP)

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Part 04 – Key Points To Remember

  • Most brokers offer live demo accounts, and these are useful in terms of mastering the basic function and navigation of the system. Having said that, nothing is better than live trading in terms of experience. Even if you keep your initial trades tiny, so you’re only risking a fraction of your account balance, that’s still hands-down the best way to get real world experience you just can’t get any other way
  • When trading CFDs, you’ve got a wide range of options and order types. It pays you to practice with the demo account before you actually make your first trade so you’ve got a clear understanding of how (and when) to make use of each of the order types
  • Stop Orders are your best friend, and absolutely essential in terms of managing your risk and mitigating losses. They ensure that when a trade goes south, you only lose a small amount of your account value, enabling you to stay in the game and recover
  • OCO (One Cancels the Other) and “If Done” orders are ideal for people who don’t have a lot of time to devote to trading and can’t watch the market like a hawk all day long.
  • GSL Orders (Guaranteed Stop Loss)

 

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PART 05: CRITICAL TRADING SKILLS

 

Analysis
Economic Analysis
Technical Analysis
Fundamental Analysis
Quantitative Analysis
Proper Position Sizing
Market Movement
Managing and Mitigating Losses
Scaling
Profit Taking
Re-Entry
Part 05 – Key Points To Remember

Making your first trade is a thrilling experience, but it also opens your eyes to all the things you don’t know. Regardless of how much prep work you’ve done, the fact remains that when you’re first starting out, you simply don’t have the skills you need to be successful in the long term.

There’s no way to get that, except time and experience.
Go out and make those trades, and as you do, here are the things you should be focused on to make you a better trader.

 

Analysis

If you’re not making trades on the basis of a solid foundation of analysis, then you’re almost certainly making them on the basis of instinct. Your gut reaction. Emotion.
That might work here and there, but it’s certainly not a good approach if you want to see long term success. Analysis is (or should be) the foundation of everything you do, and every decision you make. Good analysis is what gives you a trading edge. It’s the thing that makes it possible for you to consistently win in the market.
It should also be noted that analysis can take a number of forms, and that you don’t necessarily have to do all your own work. In fact, when you’re just starting out, it can be instructive to rely on the well-considered analysis of other traders you trust and respect, and who are pursuing trading strategies similar to the one you’re devising for yourself.
We’ll cover the major types of analysis you’ll be undertaking in the sections below to give you a feel for it.

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Economic Analysis

Traders using economic analysis to inform their trading decisions tend to focus on news releases that report on the economic performance of the company you’re looking to invest in. Much of this analysis focuses on the movement of interest rates, and for a good reason.
In general, when interest rates fall, it speeds up economic activity. When interest rates rise, it tends to curtail economic activity. Low interest rates help to increase corporate profits, while higher interest rates put a damper on them. That’s why they’re such a critical part of this type of analysis.
Having said that, there are several other economic indicators you should be paying attention to, including reports that track the rate of inflation, retail spending, housing starts, and total employment. All of these help paint a picture of how the economy is doing and what direction it’s headed in.
In the United States, interest rates are set by the Federal Reserve, and in Australia, they’re set by the Reserve Bank of Australia. These entities control the broad shape and direction of the game. They set the basic parameters the trading takes place under.
If you’re interested in Forex trading, this type of analysis is particularly important because currency valuations are highly sensitive to changes in interest rates. It’s useful (but somewhat less so) when trading share CFDs because interest rates are only one variable among many, and it requires some experience in order to properly interpret the signals you’re seeing, and how they’ll play out with regards to the company, index, or commodity you’re considering investing in.

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Technical Analysis

This type analysis focuses on price, and the ways that price moves and changes over time. Stock market prices are most often displayed as charts (lines, bars, or candlesticks). Price can then be used as a means to produce a number of indicators, which appear as lines on the chart.
With some experience at interpretation, these indicators can tell you whether or not the market is trending a certain direction, and when a turning point is likely to occur. It can also tell you if the market is in consolidation (moving sideways), with a series of up and down movements, but no clear move in either direction.
There are two great things about this type of analysis. First, the data is easy to access, so anybody with a computer can get their hands on it. Second, markets are price driven, so your analysis can be applied to any market, anywhere in the world, and as a fun side note, price movements are fractal, which means that the same trend you spot on a daily chart can also be seen on an hourly chart, or a chart that looks at a five-minute window. Pretty cool.

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Fundamental Analysis

This type of analysis focuses on the underlying performance of the company you’re researching, and makes the assumption that share price will track with company performance. In other words, if you find a company that’s going like gangbusters, it’s not really a stretch to assume that its stock price will be rising, reflecting its stellar performance.
To get a handle on how a given company is doing, your first stop will almost always be the company’s annual report and any other periodic reports they might issue. The data these reports contain can be used to create ratios that will allow you to compare different companies across different industries.
News releases are also studied closely, as companies almost always announce big expansion plans well in advance of their happening.
As you might expect, fundamental analysis is most useful when trading share CFDs, but can also provide valuable insights in the commodity market.

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Quantitative Analysis

This is often referred to as “data mining” and isn’t for the faint of heart! It will see you diving deep into historical data to find relationships that are of statistical significance. Increasing computer power is opening doors here, and making quantitative analysis more accessible to more people, but it takes patience and skill to do well.

You won’t find many charts here. Instead, you’ll be pouring through databases and creating pivot tables and decision cubes which can help you make sense of the vast quantities of data you’ll be sifting through. Using these tools, you can spot seasonal patterns, which can open your eyes to trading opportunities you wouldn’t have even known existed otherwise.

Quantitative analysis can be applied to any market, so with practice and the right tools, you can use it to analyze companies, whole industries, commodities, indices, or currencies to find trends and relationships in the data.

So which type of analysis is right for you? Ultimately, that’s going to come down to how you want to trade and what you want to trade in, because certain types of analysis are better suited to certain markets.

Having said that, there are no “right” answers here. Don’t feel “locked in” to one particular type of analysis. Be flexible. Be willing to change and try something else if you aren’t getting the results you’re looking for.

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Proper Position Sizing

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Market Movement

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Managing and Mitigating Losses

  • Percentage Stops
  • Volatility Stops
  • Time-based Stops
  • Technically-based Stops

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Scaling

  • In
  • Hold
  • Out

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Profit Taking

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Re-Entry

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Part 05 – Key Points To Remember

  • You can’t expect to find long term success without mastering the core skills of the trade. Until you feel as though you’ve gained mastery (and prove it by consistently earning profits over say, a year or more), you should trade very conservatively to help ensure you stay in the game.
  • Good analytic skills are crucial to your long-term success in the market. Note that you don’t necessarily have to do your own analysis, and in fact, when you’re first starting out, it can pay big dividends to learn by following the analysis of a more experienced trader. You do, however, need to at least be able to understand what you’re looking at.
  • No matter what type of analysis you use or perform yourself, the overriding goal is to find an edge you can use when making trades. Proper analysis is what separates failed traders from successful ones. If you don’t perform analysis, then you’re relying on gut instinct, which is essentially a roll of the dice, and that’s no way to trade.
  • Few things are more important than properly controlling your position size. This is the primary means by which you manage your risk, and is the reason that new traders are advised to keep all of their position sizes small.
  • Always adopt low-risk entry techniques and only act when all your indicators say that the market is ready to move. It’s a perfectly valid choice to do nothing…you don’t have to act on every signal you see.
  • Get into the habit of placing a stop loss order every time you enter a trade. This, combined with proper sizing will allow you to control your risk to a great degree. It obviously won’t eliminate all risk, but it will certainly make your trades safer.
  • Scaling in is another tool you can use to manage risk, allowing you to test the waters by starting with a modest position, adding to it as the market moves in the position you expected it to.
  • Holding a position is challenging and takes nerves of steel. The most important thing to remember is that trading isn’t a game of “set and forget.” You’ve got to watch the market constantly, keeping an eye out for evidence (which comes to you by way of your ongoing analysis) that conditions in the market may be about to change, which is your signal to take profits.
  • In a similar vein, scaling out is also an important tactic, as it helps ensure you lock in profits, in the event that the market unexpectedly turns against you.
  • You can use as many exit signals as you’re comfortable with to help inform you when to take profits. The most important thing is to have clear, well-defined rules and stick with them so that your emotions don’t take over and wreck your position.
  • Don’t forget that after you’ve exited a trade to take profits (or to mitigate a loss) it’s perfectly acceptable to re-enter the trade, provided that your entry criteria are still valid.

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      PART 06 LINK HERE