> Explanatory Article by Marios Kyriakou, MSc Economics
About the author: Marios Kyriakou has a bachelor’s degree in Economics from the University of Cyprus and a master’s degree in Economics from the University of Warwick. He is also a holder of CySEC’s Advanced Certificate in Financial Services Legal Framework and a professional in Online Trading, Forex and CFDs with more than 7 years of experience.
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<Last updated 25.04.2020>
Hi! If you are interested in online trading you should read the below that provides important explanation about the different asset classes.
CFDs and Derivatives
In the previous articles, we mentioned that Forex/CFD Brokers grant clients access to trading of a number of financial instruments in the form of CFDs. Usually the contract specifications of which are available on the platforms themselves or on the Broker’s Website.
We also learned that CFDs are derivative products and therefore the client is not entitled to own any underlying instrument. No physical delivery of any underlying asset shall occur.
i.e. buying 100oz of Gold CFD is not deliverable.
How CFD Works
It might seem similar to mainstream investments but is not since you never buy or own the underlying asset. The underlying asset in this example is listed Share A with a price 10 EUR.
The investor buys 1,000 shares CFDs in share A. Exposure to the Market is 10,000. Since the margin requirement is 10% the investor only pays 100 EUR. Then, the market moved from 10 EUR to 5 EUR. > Profit/Loss = -1 x 1,000 = -1,000.
We see that losses can be more than the initial margin payment.
Underlying refers to something hidden but important, something that shapes the meaning or effect of something else, without being explicit itself.
The underlying asset is the financial asset upon which a derivative’s price is based. We have seen that CFDs are an example of a derivative. A financial instrument with a price that is based on a different asset.
An underlying asset can be a stock, commodity, index, currency, or even another derivative.
Available Tradable Assets
As trading innovation continues to expand CFD Brokers provide an a number of tradable assets to its client base. Each asset class has different characteristics when it comes to Forex and CFD product offerings. On the same platform, investors can find currently (2019) the below (or more) categories of assets:
-Forex -Commodities -Indices -Stocks -Cryptocurrency
Forex / Currency Pairs
Also known as Forex or FX, the currency markets involve the constant exchange of currencies between banks and other market participants. The foreign exchange market is the world’s largest asset class and the most liquid with a daily trading volume. We have mentioned in previous units that Currencies are always quoted in pairs.
i.e. EUR/USD is at 1.10165 on January 8th 2018 at 13:41. At this point in time for one EUR (Euro) you receive $1.10165 (dollars).
–Majors are currency pairs with the largest trading volume e.g. EURUSD, GBPUSD(cable), USDJPY, USDCAD (loonie)
-Minors are currencies with lower trading volume e.g. ERAUD, GBPJPY, USDNZD
–Crosses are usually currency pairings not quoted in EUR or USD e.g. AUDNZD, CADJPY, GBPCHF
The majors are the most liquid so the spread is lower than the other categories. Minors are less liquid than Majors and more liquid than crosses.
Managing the bank rate is a method by which central banks affect economic activity. If the US Federal Reserve (FED) votes to change the nation’s key interest rates, this can affect the value of the U.S. dollar.
When the Federal Reserve increases the federal funds rate for example, it normally reduces inflationary pressure and works to appreciate the dollar. The Federal Reserve (FED) discusses key
interest rates and overall monetary policy each month.
The term “commodities” refers to natural resources that are derived from nature. Traditional examples of commodities include grains, gold, beef, oil, and natural gas. These are mostly used as raw material for other products.
Brokers have related sub-asset classes as per below:
-Metals (includes Gold, Silver, copper etc.)
-Energy (includes Natural Gas, Oil etc.)
-Agriculture (includes corn, coffee etc.)
Priced in their own individual way,
> Metals-Troy Oz, Oil-barrels, Wheat- Bushel. Commodities are in their own asset class and an integral part of financial markets.
CFD brokers offer CFDs usually for spot GOLD and OIL but there are also CFDs following the prices of the future contracts of these commodities.
During the recent Covid-19 crisis (2020) global lockdowns were implemented by governments all around the world as a measure to prevent the virus from spreading.
The business activity stopped for a long period which in turn caused a large negative shift in oil demand. A CFD investor should have anticipated that an over excess supply would eventually bring the price down and so take advantage to profit from a sell position.
An index (plural indices) always represents a particular market and measures the collective price performance of a group of Shares, usually from a particular country. Indices are often used to track and compare the performance of stock markets.
For many index investors, the S&P 500 is the most common benchmark to evaluate performance against, as it gauges the health of the U.S. economy
Indices CFDs – Standard & Poor’s
The S&P 500, or simply the S&P, measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. It is also one of the most commonly used benchmarks for the stock market.
> By taking a CFD position, a trader is essentially agreeing to exchange the difference in the price of an index from one time period to another.
i.e. CFD on Nasdaq BID price is 12,576 USD.
>The price used to sell the CFD in anticipation of future poor performance of the index.
The performance of each index is dictated by the performance of the underlying share prices that make up that index. An index is constructed and calculated independently, sometimes by a bank or by a specialist index provider like the FTSE Group. The choice of the companies included in the index is determined by index calculation rules or by a committee.
Indices tend to be affected by broader market moves which can determine the price of many companies. Typical examples include political unrest or uncertainty, national inflation statistics or unemployment numbers, or changes to interest rates.
Indices CFDs – DAX
A very popular index is the German stock index, commonly known as the DAX.
Its blue-chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange.
If the U.S. imposes new tariffs on German goods, these companies will inevitably suffer the consequences, causing the DAX to plummet on the news.
A stock price reflects the value of an investment in a company. This is determined by dividing the total value of the company by the total number of shares issued.
The fluctuation in the market is mainly determined by supply and demand. Corporate data will also have a significant influence on stock value.
i.e. Apple presents their new products at the beginning of September. Both on the official “Announcement Day”, and on the following days, the stock price of Apple tends to be volatile.
The customers process the impressions and form an opinion as to whether the new products are good or bad.
A sensational release is therefore very likely to push APPL share prices higher. On the contrary, a disappointing release will dampen demand for the product and can push APPL Price lower.
A cryptocurrency is a digital, or virtual, currency designed to work as a medium of exchange. Digital currencies use cryptography to secure and verify transactions as well as to control the creation of new units.
Cryptocurrencies operate independently of banks and governments, but can still be exchanged, or in this case (CFDs) speculated on, just like any physical currency.
Cryptocurrency CFD pairs are traded in much the same way as forex pairs, meaning that there is always a quote and a base currency in each pair.
i.e BTCUSD with base=bitcoin , quote = US dollar
This is the price per bitcoin in terms of US dollars. You can trade all the major cryptocurrencies including Ripple, NEO, Dashcoin, OmiseGO, Zcash, EOS, Iota, Monero, Bitcoin Cash, Bitcoin, Ethereum and Litecoin against a number of fiat currencies such as the EUR and the USD.
Cryptocurrencies are traded in crypto exchanges and in these markets it is observed high volatility.
Positive news can easily lead to an increase in cryptocurrency price, while negative news can lead to a decline in their value.
For instance, news that scare bitcoin users such as breaches in blockchain’s security or funds stolen from bitcoin wallets can cause prices to drop. On the other side, when governments adopt Bitcoin or state that it can be regulated, BTC prices tend to rally.
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