SPECULATING WITH FOREX CFDS

SPECULATING WITH FOREX CFDS

CONTENTS

Disclaimer

01

Introduction

02

How to Start Trading CFDs

03

CFD Basics

04

How to Trade Forex with CFDs

05

CFD Initial and Variation Margin

07

Advantages and Disadvantages of Using CFDs

09

Disadvantages of CFDs

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SPECULATING WITH FOREX CFDS

DISCLAIMER

The information contained in this eBook is provided for information purposes

only. The information is not intended to be and does not constitute financial
advice, is general in nature and is not specific to you. Before using the
information contained in this eBook to make an investment decision, you
should seek the advice of a qualified and registered securities professional
and undertake your own due diligence. None of the information contained in
this eBook is intended as investment advice, as an offer or solicitation of an
offer to buy or sell or as a recommendation, endorsement or sponsorship of
any security. Orbex is not responsible for any investment decision made by
you. You are responsible for your own investment research and investment
decisions.

RISK DISCLOSURE
There is a substantial amount of risk in trading currencies and CFDs and the
possibility exists that you can lose all, most or a portion of your
capital. Orbex does not, cannot and will not assess or guarantee the
suitability or profitability of any particular investment or the potential value
of any investment or informational source.
The securities mentioned in this eBook may not be suitable for all
investors. The information provided by Orbex, including but not
limited to its opinion and analysis, is based on financial models believed to
be reliable but it is not guaranteed, represented or
warranted to be accurate or complete.
Your use of any information from this eBook or Orbex site is at your own risk
and without recourse against Orbex, its owners, directors, officers,
employees or content providers.

01

SPECULATING WITH FOREX CFDS

INTRODUCTION

A CFD or Contract for Difference is a financial derivative that does not

expire. It consists of a contract between a CFD provider and a
speculative trader to exchange the difference between the price the
contract is initially dealt at and the price that the contract is eventually
closed out at.
If the traders view is correct and the market moves in their favor after
a CFD contract is opened, then the difference will be a positive one that
they will receive from the CFD provider. On the other hand, if the market
moves against them, then they will have to pay out the negative
difference to the CFD provider.
Forex traders can use CFDs to speculate on exchange rate movements
in a variety of currency pairs, although most CFD providers offer CFDs
in only the major currency pairs and crosses. For example, these might
include the EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD,
AUD/USD, NZD/USD and EUR/JPY currency pairs.
Dealing spreads on CFDs depend on the CFD provider, but they can be
as tight as one pip for currency pairs like EUR/USD, although one and a
half to three pip spreads are more typical. This is similar to the best
dealing spreads offered by online forex brokers.
In locations that require the payment of capital gains tax, CFD trading
profits could be taxable, while CFD losses may be tax-deductible.

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SPECULATING WITH FOREX CFDS

HOW TO START TRADING CFDS

In order to begin trading CFDs, you will need to identify a suitable and
reputable CFD provider. These companies typically now operate with
online interfaces known as trading platforms where you can open and
close CFD transactions via your computer if it connected to the
Internet.
Some online forex brokers are also CFD providers that offer CFD
trading in addition to regular forex transactions on their trading
platforms. Quite a few CFD providers even offer access to the
Metatrader 4 trading platform which gives the trader access to forex,
commodity futures and other financial instrument CFDs.
Opening a CFD account with an online CFD provider typically requires a
nominal initial investment. In the UK, some CFD providers like City
Index offer to open an account for just 100, while other CFD providers
might require higher minimum deposits.
Due to recent restrictions on over the counter transactions, the U.S.
Securities and Exchange Commission has banned U.S. citizens and
residents from trading CFDs. Some CFD websites are therefore
unavailable for viewing by people located in the United States.

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SPECULATING WITH FOREX CFDS

CFD BASICS

One of the chief advantages of trading CFDs is the high leverage

available. The maximum some online forex brokers will allow is 500:1
leverage on forex trades for non-U.S. residents, and that is equivalent to
the very low 0.2% margin requirement some CFD providers offer for forex
CFDs.
As a result, CFD trading allows the trader to take a much larger position
than they could with a direct purchase since the high amount of leverage
winds up costing them only a fraction of what a direct purchase would
entail. Under normal circumstances, a direct purchase would cost the
trader either the full amount of the transaction, 50 percent in the case of
stocks, or 20 percent in the case of futures contract.
To establish an equivalent forex position by using a CFD, a trader would
require only 0.2 up to 1.0 percent of the value of the CFD.
The effect of this high amount of leverage on a position means that a
larger position can be taken with a smaller amount of initial capital. Of
course, while profits may be magnified due to leverage, so are losses.
Because CFDs can be sold short as well as purchased, forex traders can
use CFDs to hedge existing positions or assets. For example, if a forex
trader has an existing position in a currency pair with a forex broker, they
could take an opposite position in a CFD to establish a hedged position. If
the market goes against the initial position, the gains on the CFD
position would offset the losses.

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SPECULATING WITH FOREX CFDS

HOW TO TRADE FOREX WITH CFDS

Trading forex with CFDs is much the same as trading currencies in the
spot market with some key differences. The main difference consists in
the amount of leverage on any given position. A forex trade has a
leverage ratio determined by the trader, i.e. 50:1, 100:1, 200:1, 500:1,
etc.
CFDs on the other hand, are margined as either a fixed percentage of
the trades notional value typically 0.2 to 0.5 percent or as a margin
factor, for example a 500X stake, which means 50 times the money
deposited as margin. Also, forex quantities are traded in lots such as
10,000 or 1,000,000, while CFD contracts are traded in specific amounts
chosen by the trader opening them.
A quote for a forex CFD is made with a bid and an offer, much like a
forex spot trade. The CFD transaction is margined based on the notional
value of the transaction and the fixed percent quoted by the CFD
provider, while the forex trade is margined at a specific leverage ratio.
Leverage, or holding a large position with a smaller amount of money
placed on deposit as security, is one of the reasons that CFDs have
become such a popular trading vehicle.
As an example, consider a purchase of 100,000 in a EUR/GBP CFD at
an exchange rate of 0.8550.
If EUR/GBP has a typical tier 1 margin rate of 0.20 percent at the CFD
provider, this means that only 0.20 percent of the total positions
nominal value is required to establish and hold the position. Therefore,
for this example, the margin required on that CFD position to hold it
would be ((0.20/100) X 100,000) = 200.00.
Make note that if the exchange rate moves against the position, the
resulting loss could significantly exceed the initial margin requirement
of 171.00. Also, if the position is held past 5PM New York time, then the
position is debited or credited depending on whether the interest rate on
the long currency is higher (credited) or lower (debited) than the short
currency.
In addition, the CFD provider might require additional maintenance
margin if the exchange rate has moved against the position.

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SPECULATING WITH FOREX CFDS

HOW TO TRADE FOREX WITH CFDS

If the exchange rate then moves favorably to 0.8625 the trader makes
the decision to liquidate the CFD at that price. The rate has moved up
+75 pips. The profit on the trade is (100,000 X (0.8625-0.8550)) =
750.00.
If conversely, the EUR/GBP rate declines to 0.8495 then a loss of
550.00 would be incurred: ((100,000 X (0.8495-0.8550)) = -550.00
In a straight forex trade at a leverage ratio of 100:1, the above
transaction would have required 100,000/100 or 1,000.00 in margin to
hold. At a leverage ratio of 400:1, the trade would cost 250.00. The CFD
transaction at a 0.20 percent margin is significantly more cost effective
than a forex spot trade even at a rather high leverage ratio of 400:1,
because it corresponds to a 500:1 leverage ratio that only requires 200
to hold.

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SPECULATING WITH FOREX CFDS

CFD INITIAL AND VARIATION MARGIN

While CFDs have no expiration date, any CFD positions held after 5PM
EST are rolled over. This means that the position is marked to market,
or any profit or loss on the position is reflected in the account, with losses
being debited and gains credited, in addition to any financing charges
based on the interest rate differential between the currencies involved.
The position is then carried forward to the next day.
Because CFDs are traded on margin, the trader must keep a certain
amount of money called the minimum margin in the account as long
as positions remain open. One desirable feature of a CFD provider is that
each trades profit and loss, along with the margin requirement, should
be updated constantly in real time and shown to the trader on their CFD
trading platform.
If the money on deposit with the CFD provider falls below the required
minimum margin level, the trader could receive a margin call. If the
margin requirements fail to be met after a margin call, then the CFD
provider could liquidate the traders position.
CFD traders are required to maintain a certain amount of margin in their
account for their positions as defined by the CFD provider or market
maker. This maintenance margin ranges from 0.2% to 1.0% for forex
trades to as much as 30% for some high risk CFDs on volatile stocks.
While leveraged positions can be extremely profitable if the traders view
is correction, if the market goes against the position, significant losses
can be incurred.
Trading CFDs on volatile markets can be especially risky, exposing the
trader to unexpected losses and margin calls during violent moves, which
could lead to the erosion of a significant portion or even all of their
trading account. CFD traders must maintain two types of margin:
Initial Margin - generally between 3% and 30% for stocks and
0.2% - 1% for commodities, indexes and foreign exchange.
Variation Margin the amount requested by the broker to hold a
position after it is marked to market.

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SPECULATING WITH FOREX CFDS

CFD INITIAL AND VARIATION MARGIN

Initial margin for CFDs on assets which display significant volatility can
be quite high and can change with market conditions. For example, after
the 9-11 attacks, initial CFD margins on stocks were raised considerably
due to the sharp increase in volatility in world stock markets.
For forex CFDs, the initial margin requirements tend to be significantly
lower for liquid, heavily traded currency pairs in calmer markets than for
thinly traded, illiquid assets in volatile markets.
Variation margin, also known as maintenance margin, is applied to
positions that have moved against the trader. For example, if a CFD
trader bought 100,000 of a EUR/USD CFD at 1.2550 and the exchange
rate closed at 1.2490 at 5PM EST, the broker would then require an
additional deposit to the account of $600.00 to cover the loss on the trade
if that amount was not already available in the account.
Conversely if the trader was short the CFD at the same price, then their
account would be credited with a positive mark to market value of
$600.00 to reflect their profit.
Therefore, variation margin can either be beneficial or detrimental to a
CFD traders cash balance. Nevertheless, initial margin is always
deducted from the traders account when a position is established and is
replaced in the account once the trade is liquidated.

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SPECULATING WITH FOREX CFDS

ADVANTAGES AND DISADVANTAGES

OF USING CFDS

Some of the notable advantages of trading CFDs include:

Liquidity CFD rates mirror the forex market to a certain degree
providing the liquidity of the forex market, as well as the liquidity
provided by the CFD provider.
Leverage CFDs require only a small deposit, typically 0.2% to 1%
for forex CFDs, which means a more efficient use of capital.
Low transaction costs typically forex CFDs trade with the same
market dealing spreads as the forex spot market, which generally
run between 1 and 5 pips.
Ease of execution with a reliable CFD provider, entering and
exiting the market is as easy as clicking a mouse.
No fixed contract size a CFD provider can customize the size of
any forex position to the traders requirements.
No expiration date CFDs do not have a fixed expiry.
Stop and stop loss orders CFD providers give traders the
opportunity to enter stop orders with ease.
Guaranteed stop loss many CFD providers give clients a
guaranteed stop loss, which means that when the contract is
purchased, the CFD provider guarantees that the trader will lose
no more than a set amount on the trade.
Daily statements and online account reporting Most CFD
providers offer sophisticated trading platforms that keep track of
positions in real time, as well as providing daily account
statements to clients.
Interest paid if a position is held in a currency pair where the
short currencys interest rate is lower than the long currency, then
interest is paid to the trader.

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SPECULATING WITH FOREX CFDS

DISADVANTAGES OF CFDS

Some of the notable disadvantages of trading CFDs

include:
Re-quotes - In volatile markets, CFDs tend to be re-quoted often.
Leverage as much of a disadvantage as an advantage, while
potential profits are magnified, so are losses.
Losses limited by the funds in your account holding a CFD in a
fast market situation can be disastrous if the losing trade is held
without a stop loss. Margin calls will make the trader deposit more
money or liquidate positions.
Over trading risk A combination of easy access and low capital
requirements can lead to over trading CFDs, so if you have a
gambling problem, you might want to refrain.
Interest charged if a position is held in a currency pair where the
short currencys interest rate is higher than the long currency, then
interest is charged similar to a forex rollover fee.
Marked to market CFDs typically have a collateral deposit
requirement, which means that any deficiency in funds for an
established position must be made up for in the account or the
account is liquidated.

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A FOREX MARKET OVERVIEW

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