Trading on financial markets can be a daunting prospect; it can be difficult to know just where to start, how much money to use and so on. For some, worried at the risks involved, CFDs may be an option.
The initials stand for contract for difference which is basically an agreement between the prospective trader and a broker to exchange the difference between the opening price and the closing price of a particular contract.
It gives you the ability to buy if the market prices are rising or sell if you see the market falling, so allows you a greater degree of flexibility and freedom in the market as you do not actually have ownership of the asset.
CFDs are not the only way into the market however. Spread betting is often a starting point for many to enter the world of trading and here are some of the basics including the very important issue of the stop-loss order.
Spread betting is basically a tax free option that allows you to benefit from market prices which fall as well as rise. It is seen as a more convenient way of trying to make a profit on the market without the complications and limitations which tend to come with physically owning a security.
It works by first deciding which asset you would like to trade in, the FTSE 100 being a common example.
Look at the direction the price is going in. If you have sufficient confidence that the price will rise, then buy. As well as deciding whether to buy or sell depending on the direction of the market, you also have to choose your position size and the stake amount that you either make or lose for every point the price rises or falls.
Another factor to decide will be the entry level; in other words the price that you will buy or sell the asset at, together with the profit target and the stop-loss level. The profit target is the price at which you will exit the market when it moves in the right directions whereas the stop-loss level is the opposite; the price you will, in effect cut your losses and exit when the market is moving in the wrong direction.
There are advantages and disadvantages to this type of trading, notably the element of risk of the market falling and you ultimately losing money. These risks can be enhanced if you either usemargin excessively or do not use protective stop-losses.
Setting the right stop-level is important, especially for first-time traders and newcomers to spread betting. This can be beneficial in that it removes from the trader the necessity to keep checking, on a daily basis, how their stock is performing on the markets.
They can be reassured that the stop-loss will operate to prevent heavy losses.
It also takes emotion out of the equation. Particularly among inexperienced investors there is a commitment to some stocks which is not always present for those more used to the markets who recognise it as purely a business decision and may move around more freely. Sticking with a particular stock out of emotion can lead to delay and increases the chances of making further losses.
The disadvantage to this approach focuses on setting the stop limit at the right level. If set at the wrong level it could be activated by short term movement in the market. So, the best advice is to set a limit which allows day to day fluctuation, while preventing a heavy downward slide.
Another word of advice for those using stop losses for the first time is not to rely on them exclusively. They do not take all the risk out of trading, so losses can still occur and you should still assess the market and take decisions accordingly.
With that in mind, the benefits outweigh the pitfalls and stop-loss orders are a vital tool to those looking to start spread betting.