A Beginner’s Guide to CFD Trading in Australia

This article will provide you with everything you need to know to start CFD trading in Australia. Contracts For Difference, or CFDs for short, allow traders to speculate on the prices of financial instruments without needing to own the underlying asset. It is important that beginners looking to get started with CFD trading understand the risks and have sound trading and risk management strategies in place.

CFD trading is a regulated industry in Australia. It falls under the jurisdiction of the Australian Securities and Investments Commission (ASIC). ASIC protects traders by ensuring brokers that offer CFD trading in Australia do so safely.

Source: eToro

What is CFD trading?

CFDs are financial derivatives that enable traders to speculate on the price movements of an asset, without having to own the underlying asset. CFDs are popular due to their flexibility, leverage, profit potential, as well as their ability to take advantage of rising and falling markets.

While the price of a CFD matches that of the underlying asset, CFDs are not intended as a long term investment based on the asset’s underlying value. CFDs are intended for trades based on short-term price changes allowing traders to speculate on the difference between the trade entry and exit price. Traders can go long, or they can go short. By going long, they buy a CFD with the expectation that the price will rise. If they go short, they sell a CFD with the expectation that the price will decline.

CFDs permit greater flexibility than traditional trading and allow traders to diversify their portfolio into foreign markets, leveraged trading, fractional shares, cryptocurrencies, short selling, and more. CFD transactions are instantaneous and highly liquid, eliminating the hassle of acquiring underlying assets like gold or oil.

This type of trading offers significant leverage, meaning that traders can control large positions with a small amount of capital, potentially magnifying returns. Due to their aforementioned flexibility, especially in terms of trade size, traders can take positions of varying magnitude based on their risk tolerance and market conditions.

There is a high degree of risk that comes with CFD trading as traders can lose more than their initial investment. Since CFDs are typically traded on margin, traders only need to put down a small percentage of the total value of the trade in order to open a position. This means that traders are often exposed to larger positions than if they purchased the underlying asset outright.

Many Australian brokers offer user-friendly trading platforms, as well as educational resources to help traders make smart decisions. With the right strategy, and risk management approach, CFD trading can be a profitable way to invest in a range of assets. As with any asset, profit is never guaranteed and traders should always consider their objectives and risk tolerance before entering the market.

Are CFDs Legal in Australia?

CFDs are legal in Australia and are regulated by the Australian Securities and Investments Commission (ASIC).

In 2020, ASIC announced changes to the way CFDs are regulated. This decision followed on from a review which found that the majority of CFD traders lose money. These regulations, designed to protect investors and limit the total loss traders can accumulate, came into effect in 2021.

One of the ways that the regulations have changed trading is that there is now a restriction on the leverage that brokers can offer. Major currency pairs are limited to 30X leverage, while minor currency pairs (including gold) have a 20X limit. Commodities (excluding gold) and minor stock market indices have a 10X limit. Shares and other assets have a 5X limit, while crypto assets are only permitted 2X leverage.

Brokers are also now banned from offering incentives (such as gifts) to encourage traders to open an account or deposit funds, and if the funds in your account are below half the margin needed to cover your open positions, one or more of your positions will be closed.

How Are CFDs Taxed in Australia?

Gains from CFDs are considered assessable income under section 15-15 of the Income Tax Assessment Act (ITAA) 1997, and losses can be claimed as a deduction under 25-40 of the ITAA. If CFDs are entered into for recreational gambling, they are not assessable for income tax or capital gains tax purposes. However, if the Australian Taxation Office (ATO) considers trading CFDs to be a profit-making undertaking, then it is assessable for tax purposes.

To determine whether an individual is ‘carrying on a business’ when trading CFDs, factors like motivation, behaviour, organisation, skill, and invested capital are considered. It’s difficult to prove CFD trading is not a profit-making activity, so it’s more likely that income or losses from CFDs will be assessable under sections 8-1 and 15-15 of the ITAA.

Traders should keep accurate records of their trading activity, including transaction details, profits, losses, and expenses. This data can be used to correctly determine taxable income and complete tax returns.

It’s a good idea to consult a qualified tax professional to ensure compliance with regulations.

Choosing an Australian CFD Broker

Choosing the right broker is essential for success. There are several factors to consider, including regulations, trading platforms, execution speed, fees, commissions, customer support, and educational resources.

The Australian Securities and Investments Commission (ASIC) is the body responsible for overseeing CFD trading in Australia. ASIC enforces strict rules to protect traders from fraudulent activity. These rules include capital requirements, mandatory risk disclosures, and client fund protection measures.

Brokers must be licensed and regulated by ASIC to offer CFD trading services. Before selecting a broker, traders should confirm that the broker is regulated by ASIC.

Most brokers offer demo accounts, enabling traders to practice trading by using virtual funds before using real money.

Another factor to consider is the trading platform itself, which should be user-friendly, and should offer advanced charting and analysis tools. Traders should compare the fees and commissions that are charged by the broker, including spreads and overnight financing fees. Excellent customer support is also important, as traders may require assistance at any time.

CFD Trading Strategies

A trading strategy is crucial for achieving consistent success. Traders must understand their own risk tolerance, how long they wish to lock in investments, and implement market knowledge to identify trading opportunities. Technical analysis tools like moving averages, Bollinger Bands, and Relative Strength Index (RSI) can provide insight into market trends.

Traders should establish clear criteria for entering and exiting trades. This process might involve identifying key price levels – like support and resistance zones – and waiting for a signal to confirm a potential trend reversal or continuation.

Stop-loss and take-profit levels are also vital components of a solid strategy. Stop-loss orders are designed to limit potential losses by automatically closing a position when the market moves against the trader’s expectations. Take-profit orders allow traders to lock profits in by automatically closing a position when the market reaches a certain level.

A trading strategy might involve identifying a strong uptrend in the price of a stock by using a combination of moving averages and RSI. The trader may wait for a pullback in the price to a key support level before entering a long position, placing a stop loss just below the support level to limit a potential downside. The trader could then set a take profit order at a key resistance level, where the price previously struggled to break through. This strategy could help the trader profit from the stock’s positive momentum while limiting potential losses.

While CFD trading offers significant rewards, it also presents high risks: market risk, leverage risk, counterparty risk, liquidity risk, operational risk, and regulatory risk. Traders can lose more than their initial investment, so it’s crucial to have a clear plan and employ effective risk management strategies.

• Market risk: Changes in market conditions due to economy, politics, or other factors, can cause sharp, unexpected price movements in the underlying asset, impacting your CFD positions. Stop-loss orders can mitigate this risk.
• Counterparty risk: There is a risk that your broker may not fulfil their contractual obligations. In CFD trading, your broker is the counterparty to your trades. If they go bankrupt or fail to meet their obligations, you may suffer losses. To minimise counterparty risk, it’s important to choose a reputable broker.
• Liquidity risk: It is possible that traders may not be able to close their positions at the desired price (or at all) due to a lack of buyers or sellers. This can occur when trading highly illiquid assets, or during periods of high volatility. To manage liquidity risk, it’s important to choose highly liquid assets, and to avoid trading during periods of low liquidity.
• Leverage risk: Magnifying your position is a common feature of CFD trading and is done by using leverage. Leverage allows traders to control large positions with a small amount of capital, increasing potential return on investment, but also amplifying potential losses.
• Operational risk: There is a risk of disruptions in the trading platform, data feeds, internet connection, or other systems used by yourself and your broker. This risk can arise from technical issues, network outages, software bugs, malware, cybercrime, or human error. To manage operational risk, choose a broker with a robust risk management system, and ensure you have access to a backup internet connection.
• Regulatory risk: Changes in regulations or laws can affect your ability to trade. Regulatory risks may arise from changes in local or international regulations, margin requirements, capital reserves, or restrictions on leverage. To manage regulatory risk, traders should keep themselves informed about regulatory developments.

Summary

CFD trading is an ASIC-regulated activity offered by many Australian brokers. It involves trading on price movements of an underlying asset without owning the asset. It’s a highly leveraged form of trading, meaning that traders can potentially make significant profits (and losses) with a small initial outlay.

Profits and losses from CFDs are typically assessable as income and deductions, not capital events.

CFD trading can be a rewarding experience for traders who put in the time and effort to learn the ropes. However, it does come with risks, so it’s vital to have a clear trading plan and risk management strategy.

By following the advice outlined in this article, beginners can confidently commence their CFD trading journey.

FAQs

What Are CFDs?
Contracts For Differences, or CFDs for short, are a type of financial instrument that allows traders to speculate on the price movements of an underlying asset without having to own it. A CFD is an agreement to pay the difference in the price of an asset from when a trade is opened to when it is closed.

How Do CFDs Word?
A CFD is a contract between a trader and a CFD broker to pay the difference in the price of the underlying asset between when the contract is opened and when it is closed. A CFD trader never owns the asset they are speculating on, they simply receive a return (or make a loss) based on the change in the price of the asset.

How to Trade CFDs in Australia?
To trade CFDs in Australia you will need to open an account with a regulated CFD broker. It is wise to first practice in a demo account, before trading with real money, so you can learn about how CFDs work and develop your trading strategy. You should also have a risk management plan in place to ensure that you don’t risk more than you can afford, as the value of CFDs can go down as well as up.