The two critical numbers to know when you are trading is the risk reward ratio and the winning percentage or hit rate. Understanding these numbers will go a long way to improving your trading.

The risk reward can be calculated by averaging all the wins and dividing by an average of all the losses. The risk reward clearly displays how large your profits are when compared to your losses. The hit rate is simply how often you win and is a count of the winning trades divided by a count of all the trades.

Lotto versus CFDs

Most people have bought lotto tickets at some point in their life, however is lotto the way to riches?

The attraction of lotto is the low outlay or risk. If you lose it only costs you $10 and if you win the returns are potentially enormous, maybe $10 million. The risk reward of Lotto is 1 million:1. This is an excellent risk reward ratio and one you are very unlikely to find anywhere else.

However if it was that easy we would have all won lotto. This is not the case and while the risk reward is exceptional, the hit rate is lousy. Assuming that the lotto draw requires 6 balls out of 40 to win then the chance of buying the winning ticket are 3,838,380:1.

If we were to play Lotto 3,838,380 times then we would expect to win once and lose 3,838,379 times. This means we would win $10 million once and lose $38,383,790, overall losing $28,383,790.

Winning Lotto is more about luck than probability as you may win before you buy you 3,838,380 ticket. But when it comes to building a profitable trading strategy it is not about luck it is about taking advantage of an opportunity that has a profitable edge.

Can Betting On Rugby Improve Your Trading?

The Crusaders have dominated the Super 14 rugby series in New Zealand in the last 10 years as they won 7 years out of the last ten.

In 2008 a gambler placed a $100,000 bet on the Crusaders to win a game at odds of just 1.08. This means that if the Crusaders won the gambler would have received a payout of $108,000, making a profit of just $8,000, but if they lost the gambler would lose $100,000. This is a lousy edge ratio with the risk reward ratio of 8 to 100 and a potential big loss for a very small gain.

Despite the lousy risk reward the probability of success is very high. If the probability was greater than 90% that the Crusaders would win then this could be the basis of a profitable strategy.

Calculating the probability of a team winning a game is not an easy task, but assuming the odds were 95%, then the gambler would win 19 times $8,000 and lose $100,000 just once. It could be that our gambler had a profitable strategy despite the lousy risk reward.

Successful trading is about following a profitable strategy and by using a combination of the hit rate and the risk reward you can ensure the strategy provides you with an edge.

There are a number of books available dedicated specifically to CFDs. The majority of the CFD books have been written by Australian authors and traders and the books cover all aspects of trading Contracts for Difference (CFDs).

Eva Diaz - Real Traders 2

There is a wide variety of CFD traders featured in Eva Diaz’s book. This is a look at real traders and how they use CFDs in the markets. Dave Limburg was one of the competition winners in a CMC Markets trading competition running up a profit of 441% in 9 weeks. Dave Limburg is just one of the featured trades in this CFD book.

Jeff Cartridge - Supercharge Your Returns with CFDs

I cannot write an independent review of this book as I wrote the book myself. I attempted to put together a book that covered everything from the basics of how a CFD works through to the psychological game that is a part of trading success. It includes a variety of strategies as well as a comprehensive section on risk management. The book was translated in to German as well.

Contracts for Difference by Catherine Davey

The first CFD book launched in Australia was Catherine Davey’s book simply titled Contracts for Difference. This provides good coverage of the basic mechanics behind CFDs and how to trade them. A large section of the book is devoted to technical analysis that can be found in many other books as well. The book was sponsored by a CFD provider and the provider is featured throughout the book.

Making Money from CFD Trading by Catherine Davey

Catherine’s second book profiles her journey in taking a $13,000 CFD account and turning it into $30,000. This is a great insight into what it takes psychologically and emotionally to trade CFDs as Cat embarks on the journey to make money with Contracts for Difference (CFDs).

“Trading ASX CFDs, Options and Warrants the ASX Way” written by the ASX

This book was published by the ASX and takes a look at the benefits of using ASX CFDs and other derivative products to trade. A sound factual overview of the trading products is available from an experienced education team.

CFDs a Traders Guide to Contracts for Difference and Technical Analysis by John Jeffery

John Jeffery has many years experience in the markets as both a trader and an educator. This book covers a lot of ground covering tools and strategies for success when trading CFDs. It also covers the background behind CFDs and how trading CFDs compare to trading other derivatives. It is a well rounded book.

The Best CFD Book Available

Which books is best will depend on what it is that you are looking for as all the books look at trading in different ways. For an insight into what it takes to trade on a daily basis check out Eva Diaz’s book or Catherine Davey’s second book.

If you want the mechanics of ASX CFDs and derivatives then the ASX book is the obvious choice. And if it is an overall view of CFDs and their application to trading then consider the books by Jeff Cartridge or John Jeffery.

There are a wide variety of brokers available and the following points are important to consider when choosing a CFD Broker.

Three Different CFD Models

There are three ways you can trade CFDs:

- Market Maker

- Direct Market Access (DMA)

- ASX CFDs

Market maker orders are executed directly with the CFD Broker and the CFD Broker may, or may not, buy the underlying instrument as protection for the position.

Direct Market Access (DMA) orders are placed directly into the underlying instrument by the CFD Broker and when it trades in the physical market your order is executed.

ASX CFDs are traded more like stocks with orders placed into a central auction facility run by the Australian Stock Exchange. Buyers and sellers are matched up by the ASX for the trades to be executed.

What Do You Want To Trade?

The easiest way to choose between these three execution models is to determine what you are likely to trade. To trade overseas shares, indices or currencies, you will have to choose a market maker model or a limited selection is available through the ASX CFDs.

If ASX stocks are you trading instrument of choice then you can use all of these methods to execute your trades. DMA (Direct Market Access) is available on ASX stocks only.

Step 2 for Choosing a CFD Broker

The choice now comes down to whether you wish to use guaranteed stops and once again pushes towards the choice of a market maker platform, although Macquarie does offer guaranteed stops on a DMA model.

To trade during the auctions at open and close you will have to use either DMA execution or ASX CFDs. The market maker model does not allow you to participate in the opening and closing auctions.

If you want complete transparency, where orders that you place are visible in market depth you will opt for the ASX CFDs or DMA execution.

Which Platform Do I Use?

Whichever CFD broker you use there are a wide variety of trading platforms available. Trading platforms typically include quotes, charts, and news feeds. All your CFD trades can be executed through these platforms with a variety of different types of orders.

Test drive the platforms using the free trials that the CFD brokers offer to find one that suits you. The trading platform will often make the decision for you on which is the best CFD broker.

Decide what it is that you want to trade and how you want to do that, to help you select the CFD broker that will work best for you.

The Australian Stock Exchange (ASX) has recently listed ASX CFDs for stocks, indices, currencies and commodities. The ASX CFDs are identical to the CFDs issued by other CFD providers in the market, but there are a few differences in the way they trade.

How to Trade ASX CFDs

To trade ASX CFDs you have to open an account with a broker that has been approved to trade ASX CFDs. CFDs are then traded like shares with orders placed into a central order book and executed on a price and time basis. The first order placed at a set price is always traded first.

Because the ASX provides a central market place and standardises the CFD contracts it is possible to buy an ASX CFD through one broker and sell it through another broker. This is not possible when you use other CFD providers as all positions opened with the CFD provider must be closed with the same CFD provider.

ASX Guarantees Their CFDs

The ASX stands behind their CFDs with their guarantee fund which can be called on if a broker was to default. Other than the requirement of ASIC to segregate client money from that of the CFD provider, there is no guarantee in the event that a CFD provider was to default.

The ASX CFDs offer a unique feature which allows a trader to swap the CFD position for a physical position in the underlying stock. This can be achieved at the exact same price and is conducted by the broker as an off market transfer. This is not available if you are trading with other CFD providers.

Disadvantages of ASX CFDs

ASX CFDs suffer from a lack of liquidity as they rely on other traders to take the other side of the trade. When trading with OTC (over the counter) CFD providers the CFD provider always takes the other side. Liquidity is equivalent to the underlying instrument in the OTC CFD market.

The other mechanics of ASX CFDs are very similar to Contracts for Difference (CFDs) issued by other CFD providers.

CFDs have taken the trading world by storm. Now take advantage of this revolution and learn CFDs yourself. CFDs offer the trader access to leverage to super size your returns. A deposit of just 1% will allow you to trade at leverage of up to 100 times. An investment of just $100 allows you to trade up to $10,000 of a currency, commodity, index or stock.

Amplify Your Results with Contracts for Difference (CFDs)

This means a small profit is magnified many times over when trading CFDs. Consider buying 1000 BHP Billiton at $29.00. Traditionally a trader would have to spend $29,000 to do this and if they were able to sell BHP at $32.00 the trader makes a gain of $3,000 or 10.3%.

When you learn CFDs you can buy 1000 contracts of the stock for a 5% margin or just $1,450 down. If you were able to sell your stock at $32.00 you still make a gain of $3,000 but your return has skyrocketed to 206%. Now you can see the power involved if you were to learn CFDs.

Learn to Manage Your Risk with CFDs

But not every trade goes as planned and it is important to learn how to manage your risk when trading CFDs. The market is a good teacher and you will learn this one way or another. When you learn CFDs you will know how important it is to understand and know the risks before you start trading.

Profit When the Markets Fall with Contracts for Difference (CFDs)

The opportunity to learn CFDs opens a door to making money when markets fall. CFDs can be used to profit on the way down as well as the way up. You do not have to sit on the sidelines waiting for a reversal as it is very easy to short sell with Contracts for Difference (CFDs). And trading CFDs short is easy when compared to options or warrants.

Choose When You Want To Trade

CFDs are available for a wide variety of markets from commodities to indices, stocks to currencies. With such a wide selection of markets there is something to trade 24 hours per day. So pick a market to trade that works in with your schedule.

Start trading CFDs today and learn CFDs.

Being a relatively new trading instrument there was no taxation ruling on CFDs when they arrived in Australia in 2002. Applying existing legislation to Contracts for Difference made them tax free as the closest link was to gambling. Some might assume that CFDs and gambling are closely related the Australian Tax Office did not agree. They fast tracked legislation that addressed tax on CFDs.

Talk To Your Tax Advisor

It is important that you consult your own accountant or tax adviser when it comes to tax time. Everyone’s financial situation is unique and the general guidelines here may not address all aspects of your tax situation. This is a guide to the interpretation of legislation regarding CFDs in Australia.

CFD Profit is Treated as Income

Any profit made when trading CFDs is treated as taxable income, and any losses made reduce taxable income. So the income for tax purposes is the net income calculated by adding up all your profits and taking away all your losses.

Maximise Your Tax Deductions

Any expenses associated with trading CFDs can be tax deductible. This includes costs like internet fees, any interest, brokerage or trading platform charges. These can be claimed to reduce your taxable income.

CFDs and Capital Gains

Holding a CFD position for 12 months or more to claim a capital gains discount is not a useful strategy when trading CFDs. Your gain or loss is treated as income so capital gains tax does not apply. Likewise franking credits on dividends are not received when trading CFDs so these cannot be claimed.

CFD Tax Outside Of Australia

There are a few things to watch if you are outside of Australia as well and once again tax advice from a local accountant is important. In New Zealand it may pay to trade Contracts for Difference (CFDs) through a different entity so you are not classified as a trader by the IRD which could potentially impact your investments. In the UK spread betting remains non taxable, but the penalty for a trader is a wider spread paid on each transaction.

The Last Word On Tax on CFDs

While it is vital for you to know your taxable situation this is not the reason to trade CFDs. It is not a wise investment decision to lose $1 to save 30 cents.

There are certain silly mistakes that all traders have made at some point in their trading careers, even though there are simple techniques that can be used to avoid them.

Buy or Sell, Which Button Was That

It is not unusual for a trader to push the wrong button when entering or exiting from a trade. It is most common to push sell to get out of a short position, when you really meant to buy. Sometimes it just gets so confusing, so instead of being out you end up with double the quantity.

This mistake is easily caught by checking in with your open positions after you place a trade to ensure that the trade you have placed did what you expected. If caught immediately this mistake is easily rectified and is likely to only cost a small sum for a stupid mistake. If you do not realise your mistake and the position is left open this can have disastrous consequences for your account.

Forgotten Stops

If you exit an order when you are watching the screen, make sure you remember your stop orders. Assuming you have placed a stop on the trade, which you always should, then you must cancel the order if you exit before the stop is triggered. Forgetting your stops is a risky exercise and if the stop is triggered it could be hours before you know that the order was traded. The market may move in your favour, but it is not something I would like to gamble on.

Before exiting the trading platform at the end of a trading session make sure you check your open positions match your stop loss orders to avoid any surprises when you next enter your trading platform.

Was That $10000 or $100000

Assuming the trader has the discipline to calculate their position size in the first place, sometimes it is possible to get it wrong. The most common error here is not usually bad maths, it is incorrectly entering the number of zeros. Too many zeros and your risk increases 10 times, too few and your profits evaporate.

When you look at the open positions after you place an order you should be easily able to verify that the order you placed was the correct size.

Avoid Placing Your Stops Too Tight

If a stop is placed too close to the current price, it is very likely that the stop loss will be triggered by normal price movement. While the trader that places a tight stop is attempting to avoid losing money, this is often the end result of their actions.

Stops must be placed far enough away from the price action to exit you from a position if your trade view turns out to be wrong. Give the underlying share room to move to avoid getting caught by this CFD mistake.

Follow The Rules

Even experienced traders can be caught out by chasing a share as it moves rapidly. While it is more common amongst people new to trading it still can catch out the more experienced traders. Following this strategy is usually a recipe for disaster and also can be one of the hardest mistakes to overcome.

There are a huge range of opportunities that you can trade, more than you would have capital to follow and there are always other trades waiting around the corner. Ensure you follow your strategy and stick to your trading plan. This can help you avoid chasing trades which can be an expensive exercise.

While no trader will be right every time, these silly mistakes can be easily avoided or caught before they have any real impact on your account.

The leverage that is available when trading CFDs is one of the most important CFD risks to manage. With a small amount of money you can control a very large position and profits or losses can occur rapidly.

Stops Are Essential

Stops work very well to limit your CFD risk. Place your stop at a price that will control the loss per contract to an acceptable level. This is an effective way to manage your risk.

With an entry at $34.50 and a stop placed at $34.20 your loss is limited to 30 cents per contract. If the trade goes wrong it will hit your stop loss and exit you from the trade preventing a larger loss that could occur.

Control Your Size, Control Your Loss

By placing your stop at a predetermined level the amount you lose will now depend on your position size. The more contracts that you hold the more money you will lose if the trade goes wrong. This is the second CFD risk that you can manage.

with 30 cents at risk the number of contracts will determine your gain or loss. 100 contracts would give a loss of $30, 200 contracts would lose $60 and 1000 contracts would lose $300. Bigger positions, say 10,000 contracts would lose $3,000. Correct position sizing is an important aspect of controlling CFD risk.

Beware of Gaps

Even though you have placed a stop in the market you can still get caught out by a gap. When a gap occurs the share price jumps beyond the stop loss and even though you were expecting a loss of 40 cents the loss becomes 70 cents. If the stock closed at $34.50 and opened the next morning at $33.80 the stop at $34.10 cannot be executed because the share never traded at the price. It is possible to minimise the effect of gaps using some of these techniques.

Adjust the number of contracts

Use a guaranteed stop loss (gets you out at the stop price guaranteed!)

Trade indices or currencies as they hardly ever gap

Biggest CFD Risk

The biggest risk when trading CFDs is however not related to stops or position sizing, it is instead you. Controlling your own emotions is vitally important to prevent placing a position that is too big or to move stops to prevent you losing money. If you follow either of these strategies you will inevitably lose.

Profitable trading with CFDs is a result of effectively managing your risk.

CFDs are cheap to trade and this attracts traders to CFDs when they make the comparison of CFDs versus Stocks. Using a small amount of capital to trade a much larger position is very attractive to a trader moving into CFDs after trading stocks There is nothing new to learn when it comes to the pricing of CFDs as they mirror the underlying stock prices.

Benefits of CFDs

CFDs have a wide range of advantages over stocks as a trading instrument especially for the active trader. Brokerage costs are low and even free when trading CFDs on indices, currencies or commodities. With brokerage as low as 0.08% for stock trades the low costs of CFDs make them attractive to new and experienced traders alike.

You can trade with other people’s money, because a small amount of capital controls a much larger position when trading CFDs. Leverage means a small move in the underlying stock can result in a much larger gain in the CFD position.

CFDs are easy to trade as you agree to settle for the difference between the price you get in and the price you get out. There is nothing more to it. This makes short selling as easy as trading long, simply sell first and buy back later.

Opening an Account

So what does it take to get started, just complete an application, submit it and send it with proof of who you are. With fantastic upside there comes the potential for downside as well. Manage your risk to ensure your survival and profitability. Make sure you have sufficient capital to begin trading CFDs. At least $5,000 would be recommended.

Alternatives to CFDs

Options, futures or even currency trading may be valid alternatives to trading CFDs. Options are by the most flexible trading instrument available, but CFDs are far superior when it comes to being easy to trade. You do not have to trade $25 a point with Contracts for Difference, like you do with futures, as one contract is usually equal to $1 a point. CFDs can be used to trade currencies with spot prices quoted by most brokers.

When you compare CFDs versus Stocks, CFDs are a revolution when it comes to trading.

It takes just three things to trade CFDs successfully.

1. Manage your risk.

2. Follow a proven strategy

3. Follow the rules

Always Use Stops

Stop orders can be used to provide protection when trading. The stop orders must be placed into the market to protect your capital.

The market can move very quickly and a stop placed in the market will exit you from the position, even during volatile times. Realising a small loss is much better than holding on for that loss to get bigger.

With CFDs it is possible to lose more than you have in your account, so it is vitally important that you use stops to limit your risk.

A Profitable Strategy Wins Hands Down

The next piece in the puzzle is to develop a profitable strategy. There are many ways that you can do this and there are many different strategies that you can follow. The right strategy will depend on you.

The strategy must at least work well historically. But even if it does there is no guarantee that it will continue to work in the future. There is a wide variety of trading software that allows you to test trading ideas historically.

Most traders do not follow a profitable strategy and as a result do not achieve the results they wish to. Following the market movement will have you buying at highs and selling at lows. Before you start trading make sure you know what your strategy is and that it works.

Just Do It

The discipline to stick to your strategy can take time to develop. It is not always easy to do this.

Every strategy will have times when it makes less money or even loses. Hopefully this change is temporary, but it is important to recognise if there has been a fundamental change and have strategies in place to manage this.

If the strategy is experiencing a losing streak that is beyond normal, it becomes time to stop trading and protect your capital.

Following your trading plan can be very difficult, just like following an exercise plan can be difficult to do.

Mastering these three tips to trade CFDs successfully can take some time, but the rewards are well worth the journey. Enjoy the trip.