Key Terms

Contract for Differences (CFD)

A CFD is an agreement between a ‘buyer’ and a ‘seller’ to exchange the difference between the current price of an underlying asset (shares, currencies, commodities, indices, etc.) and its price when the contract is closed.

Underlying Asset

Underlying asset are the financial assets upon which a derivative’s price is based.

Examples

• If you buy or sell a CFD on the EURUSD currency pair, the EURUSD currency pair is the underlying asset of that CFD.
• If you buy or sell a CFD on Spot Gold (XAUUSD), the Spot Gold price (XAUUSD) is the underlying asset of that CFD.

Leverage Definition

Leverage is a technique which enables traders to ‘borrow’ capital in order to gain a larger exposure to a particular market, with a comparatively small deposit. It offers the potential for traders to magnify potential profits, as well as losses.

Leveraged products definition

Leveraged products are financial instruments that enable traders to gain greater exposure to the market without increasing their capital investment. They do so by using leverage. That means opening positions much larger than his or her own capital would otherwise allow. This can increase the traders’ rewards, but it can also increase their risk too.

Margin

Margin in trading is the deposit required to open and maintain a leveraged position using products such as CFDs. When trading on margin, you will get market exposure by putting up just a fraction of a trade’s full value. The amount of margin required will usually be given as a percentage.

Margin Call

A margin call is the term used to describe that the capital of the trading account has fallen below the minimum amount needed to keep a position open. A margin call can mean that the trader has to put up additional funds to balance the account, or close positions to reduce the maintenance margin required.

Market Order

A market order is a request by an investor – usually made through a broker or brokerage service – to buy or sell a security at the best available price in the current market.

Long Position

The term long position describes what an investor has purchased when they buy a security or derivative with the expectation that it will rise in value.

Short Position

A short, or a short position, is created when a trader sells a security first with the intention of repurchasing it or covering it later at a lower price.

Lots

In securities trading, refers to the number of units of a financial instrument bought or sold. The number of units is determined by the lot size

Swap (Rollover Rate)

The rollover rate is the cost of holding a currency pair overnight. The swap rate is the rate at interest in one currency will be exchanged for interest in another currency – that is, a swap rate is the interest rate differential between the currency pair traded. The rollover rate can also be known as the swap fee.

Example of how a CFD works

You believe a listed share (Share A) is undervalued and that its price will rise. You decide to buy 4,000 CFDs in Share A at the price of 10€ per CFD. Your ‘position’ is therefore 40,000€ (4,000 x 10€). You do not actually pay 40,000€: the amount you pay depends on the margin required by the CFD provider. If the CFD provider asks you for a margin of 5%, for example, that means your minimum initial payment is 2,000€ (40,000€ x 5%). The return you get on this initial payment depends on the price at which Share A is traded when you decide to close your position (that is, when you sell the CFD).

   

If the price of Share A decreases by 5% (from 10€ to 9.5€), and the leverage is 20, you lose the total amount (-100%) of your initial margin payment, i.e. you lose 2,000€. If the price of Share A decreases by 10% (from 10€ to 9€), and the leverage is 20, you lose your initial payment of 2,000€, and your CFD provider will ask you for another 2,000€ (margin call) if you want to keep your contract open. This means that your losses may be more than your initial margin payment.