Introduction to CFDs - Tutorial

Placing orders can be a challenge. Manipulating your keyboard while keeping your eyes on the action takes a bit of practice. That’s why it’s better to start small as you don’t want fear of mistakes getting in the way of placing your entries and exits accurately. This is an Introduction to CFDs – tutorial for CFD Orders, once you’re comfortable with using these you’ll be more confident to move into the next level of your online trading

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INTRODUCTION TO CFDS - TUTORIAL ON CFD ORDER TYPES

There are many different kinds of orders. However, to keep things simple we’ll start with the basics. Every order has particular rules around it. It’s important to understand these before you enter an order. Read the CFD Providers PDS carefully and keep referring to it so you are aware of all your rights and responsibilities, and what the CFD Providers rights are as your provider. If you’re not clear about something, stop and make contact with your Provider through Chat or by calling Customer Service.

Market order

 ‘Market or ‘at touch’ order means to buy or sell at the current market price. A buyer must pay the Offered price whereas a seller will receive the lower Bid price. A Market order can be placed to enter a new position or exit an existing one.
Market Makers (MM) may wish to requote you as they are mirroring the real market a Direct Market Access (DMA) Provider allows you straight through processing to the real market

Limit order

A Limit order may be used to either open or close a position at a predetermined price.

Limit orders may have their price improved and be executed at a level that is more favourable to you than the predetermined price you selected when placing the Limit order.

This will usually happen at the underlying reference instrument’s opening price for the day, where the opening price is more favourable to you than the Limit order you have placed and there is sufficient liquidity in the underlying market for Providers to replicate the trade. The price for a Limit order is unlikely to be improved during the course of a trading day.  This refers to MM

An example of where a Limit order may not be improved on the opening price of the Underlying Reference Instrument includes, a situation where the your Limit order price is reached in the Underlying Reference Instrument but there is insufficient volume for CMC Markets to replicate the trade. Any price improvement to Limit orders are at the absolute discretion of the Market Maker (MM) whare as a DMA you will be traded at the real market price from the market depth order flow

The Limit order can be used for both directions a Limit Buy or a Limit Sell to enter the market:

•           If it is a Limit Buy then you need to set the Limit price order under the current market price because if the market comes down and touches your price, the order will then be filled. This refers to MM As some MM will not let you set a limit order above the price

•           If it is a Limit Sell then you need to set the Limit order price above the current market price because if the market comes up and touches your price, the order will then be filled. – Once again this refers to MM

Stop Loss order

This is an order that tells your CFD Provider at what point you want to get out of a trade when the position turns against you. These orders are usually used to close a position and is a useful risk management tool. It can also be used to enter an Index or the overseas markets.  A Stop Buy order is always entered at a price higher than the current Offered price. Conversely, a Stop Sell order is always entered at a price lower than the current Bid price.

Stop Loss orders must be placed a minimum distance from your providers current CFD bid and offer prices. The minimum distance away for a Stop-loss order placement is specified in the your providers Product Schedule per instrument and will be advised to you upon request.

As a guide a Stop Loss order must be set two times the spread plus 1.

If liquidity is insufficient or a CFD gaps over your Stop Loss order price your order may be filled at prices inferior to those at which they were originally placed. It is very important to read your providers PDS off their website do you are very clear about the orders and other matters, the PDS is one of the first documents you should read – know the rules of the game!

Choice of Stop-loss level

The choice of a stop loss level should be based on the time frame of your trading. Generally, shorter term traders tend to have tighter stops than longer term traders but some short term traders don’t use stop orders at all.

A stop loss is generally placed around a support or resistance level but with some ‘gap room’. This means placing the stop order a few cents under a support level in the case of a Sell Stop or a few cents above a resistance level for a Buy Stop.

Moving your Trailing Stop loss

A stop loss can be “trailed” or moved as the market moves in your favour. This protects the position against a reversal. Remember also to give the trailing stop some gap room.

Technical protection means a stop is placed around a charting level. Order book protection means placing a stop level around existing orders in the market. By consulting market depth a sell stop would be placed above a large volume Offer or in the case of a Buy, placed below a large Bid.

It is important to understand how your stop loss is executed. Your providers execute stop loss orders in the same way an institution would execute a derivative order. The process involves the use of data known as ‘the course of sales’, which is a record of each price traded with the time it was executed. When a stop level is traded the stop order is executed at the same price or the next price traded on the course of sales.

Stop Buy (Stop Entry) order

The Buy on stop order can be used in all markets except the ASX shares CFDs.

This order allows you to open a trade when a certain price level is hit above the current Market price. This is for some of the Market Makers, make sure you check on this aspect!

If-done order

If-done orders are simple and versatile, also known as Contingent orders.. This is the combination of two orders, with the second of the two orders only becoming active should the first order be executed. For example, you may place a Limit order or a Stop-entry order contingent on another Limit order or a Stop-entry order being executed.

OCO (One-Cancels-Other )

This is the combination of both a Limit order and a Stop-loss order where the execution or cancellation of one order will automatically cancel the other order.

It is an order type that may be used to take a profit if the market moves favourably for your open position or to potentially limit the loss if the market moves against your open position. It may also be used to open a new position. This order type can be placed to open new positions in all CFDs but not Share CFDs on ASX shares.

Using the OCO saves time and mistakes. Many new traders forget to take stops out of the market, they may have a Stop order in the market and decide later to exit the market via a Market order, leaving the Stop still active in the market and that order may later be filled.

It is very important to always check the Pending orders / Client Position Keeping  to make sure there are no orders that you are not aware of.

 

Guaranteed Stop Loss order (GSLO)

A Guaranteed Stop-loss order (GSLO) can be used to close or reduce a position, with your CFD Provider guaranteeing your stop out price. A GSLO can be placed on all Share and Index CFDs not on Forex, Bullion, Commodity or Treasury CFDs. Guaranteed Stop-loss orders (GSLO) are accepted at Your Providers discretion and may only be placed over the telephone with You Providers dealing desk.

With a GSLO, you know the price at which you are prepared to be closed out, and are not exposed to “gapping” in Your Providers prices or illiquidity in the market which may lead to your position not being closed out or being closed out at a price worse than that specified by you when you placed the Stop-loss order.  This means a GSLO enables you to have a known “worst case scenario” should the market move against you.

However a GSLO is subject to some additional conditions (also see the PDS):

•           can only be placed by telephone;

•           cannot be used to open or reverse a position;

•           they can’t be placed outside the trading hours of the Underlying Reference Instrument;

•           Your Provider guarantees your close out price, there is a premium charge applied to your Account when placing the GSLO

The time of day an order is placed is important

There are two important distinctions in timing. The first is placing an order ‘in-hours’ during the trading session and the other is placing an order ‘out-of-hours’ when the market is closed.

An out-of-hours order is placed when the order book is closed. Despite this, there are factors affecting the price due to other events and circumstances occurring around the world. For example consider BHP Billiton and Rio Tinto, which have dual listing. A trader should take into account the overseas activity related to that Share CFD before placing an order out of hours. These could include factors such as the value of commodity prices. For example, the price of Gold will affect the value of Newcrest Mining or a fall in the value of the US dollar may affect News Corp because it derives most of its income in US dollars.

The GSLO must be placed a minimum distance away from the current CFD price being quoted by Your CFD Provider. The minimum distance is measured as a percentage movement from the current CFD price.

•           GSLOs cannot be placed in the last hour of trading for Share and Index CFDs

•           Your Provider may vary the terms of a GSLO to take into account a fundamental change in the price of a CFD such as the payment of dividends or the facilitation of corporate actions

Amending a GSLO, by changing the stop loss price means you will have to cancel the existing GSLO and place a new GSLO resulting in paying an additional premium for the new GSLO and will be subject to your CFD Providers’ accepting the new GSLO. It is important to note that the acceptance, amendment or cancellation of a GSLO is at the sole discretion of Your CFD Provider. This is for MM, check your Providers PDS as their format and processes are always changing, check for the latest on your providers website

Order Durations

Day orders

A day order is an order that is good for the day on which it is placed only, may not execute, and will be cancelled by your CFD Provider if unexecuted at settlement time. If you want to maintain that order in the market after the Settlement Time, you will need to resubmit the order. 

Good ‘Til Cancelled orders (GTC Orders)

A GTC Order means that the order you place will remain in the Your CFD Providers system until it is either executed according to the terms of that GTC Order or cancelled by you.  Your Provider can cancel a GTC Order for example, due to the delisting of an Underlying Reference Instrument or insufficient equity balance in your account.

Cancelling orders

If you close a position, you must cancel any related orders you have placed against that position. Failure to do so will mean that the order remains at risk of  execution.

This relates specifically to linked orders (e.g. If-done and GTC orders). Though these orders act in combination or in sequence, you have to make sure that all ‘linked’ orders to any position you make are cancelled or de-linked once your order is done.

It is suggested that you check and double-check your order entry and types to avoid any error.

Usually if it is a straight forward long or short position to enter a trade, the order will be closed once you take the opposite trade. For example, you went long 500 share CFDs of BHP. Once the price has moved to your expected direction and you want to take profit, what you have to do is to go short 500 BHP share CFDs and this will close your long position. There are differences between DMA and MM Providers!

Margin calls and liquidation notices, why when and how?

What is Margin?

Margin is the amount of deposit required to secure a position. It ranges between 1% for Index and Sector CFDs and from 3 – 50% for individual Australian Share CFDs. The Margin is calculated as a percentage of the notional value of the position and is charged to cover the traders’ account in the event that the position moves against them. The margin amount is returned to the trader when the position is closed out.  The Margin requirement for a particular CFD may be increased by Your Providers at any time, for example, as a result of corporate actions or due to the suspension of trading of the underlying instrument.

If the market moves against you and your equity balance falls below your Initial Margin you have the option to:

•           close one or more of your open position(s), in order to reduce your Initial Margin to the required level; and/or

•           remit further funds to your Account as deposit in order to maintain the Initial Margin.

This is the first trigger level for margin, referred to as the ‘Margin Call’.

The minimum Total Equity balance required to hold a position in an Index or share CFD, after you have opened your Account is 20% of the Total Margin Requirement or USD$200 or its  currency equivalent, whichever is greater.  Check with your CFD Provider!

If your equity falls below your Initial Margin requirement, it is advisable that you place a Stop-loss order to try to avoid a deficit balance on your account.

The amount of the additional Margin may be substantial. If you fail to provide those additional funds when required, your position may be liquidated at a loss and you will be liable for any shortfall in your CFD account resulting from that failure. Positions are marked to market on a daily basis with payments being settled daily to account for market movements.

Your CFD Provider  may require the payment of additional Margin during the term of a CFD, in addition to the Margin required when you enter into a CFD transaction. Failure to pay additional margin requirements promptly may result in:

•           some or all of your open positions being closed or liquidated by your Provider.

•           you being prevented from opening new positions or extending existing positions

•           you being liable for interest charges on negative or debit balances

Fees

Like trading shares or taking a margin loan, trading CFDs may involve other fees and charges on top of the actual price for trading it.

Financing components of a CFD trade

Commission

This is similar to the broker fee you pay to trade physical shares with your stock broker or a discount brokerage company. One advantage of trading CFDs is that commission or broker fees are relatively lower compared to what you pay your stock brokers. Some CFD providers charge as low as $7 to $20 commission for trades of up to $10,000. On the other hand, stock brokers usually charge at $20 to $30 for each trade and much more for the few that can short sell.

Margin

A CFD is a derivative product and is traded on margin, which means you only need to put up a fraction of the total position to open a trade. The margin is the amount you need to have in your trading account, which may vary from 3% - 10% depending on the CFD you trade. Index and Sector CFDs and margin FX trades only require 1% margin.

Examples of margin requirements in opening and closing trades 

The following examples are provided for illustrative purposes only.

Assumptions for the illustrative examples:

•           All trades are made on the same day.

•           No corporate actions occur during the holding period.

•           Other fees and charges may apply to your trading.

a. Opening a Long position in the ASX200 CFD Index and making a Profit

The CFD provider is quoting the ASX200 CFD Index at:

Bid 4,999 / 5,000 Offer

Every one-point movement in the Index is equal to $1. Therefore. buying 10 ASX200 CFDs means each one point move is equal to $10.

The Margin requirement is based on the number of CFDs multiplied by the value of the Index:

5,000 x 10 x 1% = $500.00

Closing a Long position in the ASX200 Index

A month later the ASX200 Index is trading at:

Bid 5,146 / 5,148 Offer

The trader sells 10 ASX200 CFDs at 5,146

The profit is calculated as:

(5,000 – 5,146) x 10 = $1,460 Profit

SUMMARY:

Margin used (“money in”) at entry $500.00 (10 x 5,000 x 1%)

Total Position Size/ exposure at entry      $50,000.00 (10 x 5,000)

When you close your position you receive the margin back into your available funds as well as a $1,460 profit (less applicable finance costs).

b. Opening a Short position in ASX200 Index and incurring a Loss

A trader decides to take a short position of 10 ASX200 Index and is quoted:

Bid 4,998 / 5,000 Offer

The Margin requirement is based on the number of CFDs multiplied by the value of the Index:

4,998 x 10 x 1% = $499.80

Closing a Short position in ASX 200 Index

A month later the ASX 200 Index is trading at:

Bid 5,070 / 5,072 Offer

You buy 10 Aussie 200 at 5,072

The profit is calculated as:

(5,000 – 5,072) x 10 = $720 Loss

SUMMARY:

Margin used (“money in”) at entry $499.88 (10 x 4,998 x 1%)

Total Position Size/ exposure at entry      $49,988.00 (10 x 4,998)

When you close your position as per the above example, you lose your margin of $499.88 and an additional $220.12 to equal a $720.00 Loss. (and receive applicable finance costs).

Holding a position overnight

If you hold your long Share or Index CFD position overnight and do not close it before the Settlement Time, you will incur a financing charge at your CFD Provider Financing Rate, which would reduce your profit or increase your loss.

If you hold your short Share or Index CFD position overnight and do not close it before the Settlement Time, you will be credited an amount at the your CFD Provider Financing Rate, which would increase your profit or reduce your loss.

a. Example of a Finance charge on NAB Long

The finance calculation is based on the current overnight rate plus a premium and is based on the full notional value of the position. It is deducted from the account on a daily basis

Current RBA rate is 6.00%, add 2% = 8.00%

Interest paid by the client on a long NAB position of 400 shares worth $37.50 each is calculated as:

400 x 37.50 x (8.00% / 360) = $3.33 per day

b. Example of a Finance charge on NAB Short

The finance calculation for a short position is based on the current overnight rate minus a discount and is based on the full value of the position. It is deposited in the client account on a daily basis

Current RBA rate is 6.00%, less 2% = 4.00%

Interest paid to the client on a short NAB position of 400 shares worth $37.50 is calculated as:

400 x 37.50 x (4.00% / 360) = $1.66 per day

NOTE: The RBA Rate can change at any time and different premiums may apply to different markets. The above demonstration is for illustration purposes only.

Financing cost 

As a margin traded product CFDs attract financing charges, which is similar to paying interest on a margin loan from a bank to buy shares. Technically, when you open a CFD trade on a margin, your CFD provider is lending you the money for the rest of the amount. Financing cost varies from one CFD provider to another, so it is wise to check what you will be charged.

One thing to note with financing cost is that you have to pay it if you have long CFD positions, but you will be paid an interest if you have short CFD trades. This is because technically, you are lending money to the CFD provider when you open a short trade and therefore you are to be paid interest.

Finance cost computation 

For example, the official cash rate is 6% (interest rates are set by each country’s central bank) and a CFD provider will charge an administrative premium of say 2-4%. Therefore you will be charged a minimum of 8% on the total value of your CFD trade on a daily basis for as long as you hold the trade.

BHP ‘long’ position financing cost

($8,400 x 8%) 360* = $1.86 per day

This amount will be reflected in your daily account statement from your CFD provider

Note 360/year is the industry standard for calculating financing costs.

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Pricing and quotes

Spread

Because of the difference between the buying and selling price of a CFD, the relevant CFD price must move favourably before you can break even. In other words, even if the CFD price does not move at all and you close out your position, you will make a loss to the extent of the spread and of any Your CFD Provider charges and commissions which have been charged.

Slippage

Slippage is the difference between the price an order is executed (filled) and the price it was entered. Slippage may occur in fast moving markets where price changes rapidly and where volatility is extra-ordinarily high. Slippage can also happen when there are price gaps (particularly big gaps).

For example, you entered a share CFD trade at $5.00 and you nominated an exit stop at $4.85. However, the following day the price of the share CFD gapped down on the market open by $0.50 cents. Due to this big gap, most likely you will not be filled or your order to exit will not be executed at the nominated price of $4.85. It may be filled at $4.50 (if the price does not move any lower later on the day) therefore you have a slippage of $0.35 cents.

To minimise or control slippage, you can use the various risk management tools including guaranteed stop loss (GSLO) order. This may involve a small premium, but it will let you quantify and control losses in case of big price gaps. Slippage occurs when the execution price is different to the stop order price. Slippage can be minimised by checking market depth. The amount of slippage can be affected by how and where you place your stop

Requotes - From Market Makers (MM)

Where the volume of CFDs you wish to deal in is not reflected in the Underlying Reference Instrument (Index or share CFD) or  in the Underlying Market, your CFD Provider may re-quote the price at which it offers the CFDs to you to reflect this lack of buyers and sellers. 

your CFD Provider may also re-quote the price at which it offers the CFDs to you, when the sum of  all requests for orders at a particular price, or range of prices, determined by your CFD Provider, exceeds that available in the Underlying Market to which your request to place an order relates. You always have the option to either accept or reject the re-quote.  

Mark-to-market

Mark-to-market refers to the daily reconciliation or validation of an account at the close of each trading day. This is particularly important considering the dynamic nature of the market where traders can see price movements in real time (most of the time and in most cases). Mark-to-market also involves calculating all profit and loss items on a particular position to make sure that it has sufficient fund and that all margin requirements are being met.

Self-assessment exercises:

1. How fast can you contact your provider, phone, chat, email for instant help?

2. Where do you find online tutorials about placing orders?

3. How do place a Market order?

4. How do you place a Stop loss order?

5. How do you place a Limit order?

6. What does OCO  stand for? Give an example of one.

7. What would you use an If-done order for?

8. How do I place a GSLO?

9. What do I need to do morning and evening?

10. How do I get money out of my account? What is the quickest way to deposit funds?

11. How much free equity do you need to maintain in your account?

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