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Key Takeaways
Lots are the standardised units used to size derivative contracts.
A limit order instructs your broker to fill your buy or sell order at a specific price or better.
A stop order activates a market order when a certain price has been met.
Stop orders avoid the risks of no fills and partial fills but you may end up with a lower or higher price than you expected.
The information in this course general in nature and does not take into account your personal financial circumstances, objectives, or needs. It is for information and educational purposes only and should not be considered personal financial advice. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
Understanding the theoretical application of derivatives is only the first step. Operating successfully within the market requires a strict understanding of platform mechanics, execution costs, and how your capital is utilized the moment a trade is placed.
Longing and Shorting
Because CFDs are contracts based purely on price movement rather than physical asset ownership, they offer bidirectional flexibility. Traders can take positions based on their analysis of both rising and falling markets.
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Shorting Example
With a $1,000 USD deposit and 2x leverage, you have opened a short position for 0.02 Bitcoin. Assuming BTCUSD is $100,000 you have opened (sell) a contract valued at $2,000 USD ($100,000 x 0.02).
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To profit, you buy back the 0.02 BTC contract at a lower price, repay the exchange, and keep the leftover cash. If the price rises instead, buying it back costs more, and the exchange automatically deducts the difference from your margin deposit.
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Disclaimer
These examples are simplified for illustrative purposes and assume a fixed margin model. In live execution, required margin may fluctuate dynamically with asset prices, and trading outcomes are subject to spreads, commissions, and overnight swap fees.
Hedging
Advanced traders and institutions do not solely use derivatives to speculate; they also use them as a risk management tool known as hedging.
Hedging aims to mitigate potential overall portfolio losses. It generally involves pairing two positions that are expected to move in opposite directions, if your primary investment declines in value, the hedge is intended to rise, offsetting the impact of the fall.
However, "hedging" can take several forms, and retail CFD traders in Australia must operate within strict regulatory boundaries.
Hedging Physical Assets: Using CFDs to offset actual market exposure. For example, if you own 50 physical BHP shares, you may open a short BHP CFD with the goal of mitigating the impact of a potential drop in the share price.
Inverse Indexes: Trading instruments designed to move inversely to the broader market.
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Important to Remember
Hedging is not a perfect science. While opening a counter-position can mitigate market risk, it doubles your exposure to trading costs. You must factor in the spreads, commissions, and ongoing daily overnight credit/ fees (Swaps) for both open trades.
Order Types and Risk Management
Navigating volatile markets requires precise execution instructions. Platforms provide various order types to manage entry points and mitigate downside risk. These different order types can all be executed when going long (buying) or going short (selling).
Disclaimer
Limit orders, take profits and stop loss execution is not guaranteed.
Market Orders
A market order tells the exchange to execute your trade at the best available price at that moment which may expose you to slippage. In fast-moving markets, the price can shift in the split second between clicking and filling, meaning your final price might differ slightly from what you saw on your screen.
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Limit Orders
A limit order dictates a strict boundary: you set a maximum price you are willing to pay (to go long) or a minimum price you are willing to accept (to go short). The trade only happens if the market meets your price or does better. This gives you control over your entry or exit price.
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Stop Orders
Stop Orders are often confused with Limit Orders, but they serve the opposite purpose. They are used to enter a trade once the market breaks through a certain level, confirming a trend.
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Stop Loss & Take Profit
Disclaimer
Stop loss and take profit orders are not guaranteed to execute at your specified price and are subject to slippage risks.
Stop Loss
A Stop-Loss is a pending order that automatically closes your trade at a pre-set level to cap your losses. If you are "Long" (buying), your Stop-Loss is a sell order placed below your entry.
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Take Profit
Trading isn't just about avoiding losses; it's about knowing when to leave with your winnings. A Take-Profit order automatically closes your trade once it reaches a specific level of profit.
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Important to Remember
Australia regulations mandate negative balance protection for retail traders stops you from owing more than your account balance. If losses exceed funds, your balance will be brought back to zero.
Professional traders rarely rely on a single exit strategy; instead, they use a Stop-Loss and a Take-Profit simultaneously to create a "bracket" around their open position.
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The Cost of Entry (Spreads & Commissions)
Market access carries inherent costs. Understanding these costs is vital for calculating potential risk and return.
The Bid/Ask Spread
Every asset has a Bid and an Ask price. The difference between them is the Spread.
The Bid (Sell Price): The highest price a buyer is willing to pay. If you want to close a "Long" position or start a "Short," this is your price.
The Ask (Buy Price): The lowest price a seller is willing to accept. If you want to "Go Long," this is what you pay.
The Ask is always higher than the Bid. This means that the moment you open a trade, you are slightly "in the red." For your trade to become profitable, the market price must move in your favour by more than the width of the spread.
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Interesting Fact
In stable markets spreads usually remain consistent. However, during periods of high volatility such as during major news releases, spreads can widen as liquidity providers adjust for heightened risk.
Commissions
Commissions is a service fee paid to the broker for executing your trade.
The Cost of Time (Swap Rates)
CFDs are primarily short-term instruments. Holding positions overnight introduces Swap Rates (Overnight Financing); interest charges for borrowing the capital used in your leveraged position. These fees are applied daily at the market rollover (typically 5:00 PM New York time) and can gradually erode your equity if held long-term.
To ensure account health, trading platforms automatically monitor your Maintenance Margin. If adverse market moves or accumulated swap fees cause your equity to drop below this threshold, a Margin Call is triggered.
This is a formal notice that your account is undercapitalized. Under ASIC regulations, if your equity falls to or below 50% of your total margin, the broker is legally required to automatically liquidate your positions to minimise the risk of further losses.
A Margin Call is triggered if your account equity (the real-time value of your balance adjusted for floating profits and losses) falls to or below 80% of your Used Margin. This serves as a warning that you are approaching the 50% Stop Out level.
To resolve a Margin Call, you have three choices:
Reduce your exposure by closing some positions,
Deposit additional funds to bolster your equity,
Or maintain your current positions and risk automatic liquidation if the market continues to move against you.
A Stop Out or liquidation occurs when the account’s Margin Level falls to 50% or below. Once this level is reached the system will automatically close your positions starting with those in the largest loss. Positions will continue to be closed until the equity raises above 50% of the Used Margin.
This mechanism helps limit losses by automatically triggering a closure of losing positions, in an attempt to prevent negative account balances.