Learn About CFDs

1. Getting Started
2. Determining Stock Values
3. Technical Analysis: Trends, Support and Resistance
4. Money Management

Trading stocks has gone on for hundreds of years, and yet, in the 21 st century's global economy, it is an activity that perennially increases. Recent decades have seen incredible investment and advances in stock-market technology as well as share-related instruments. As a consequence of that, never before have the benefits and excitement of the stock market been available to so many people. Certainly since the 1980s, it has not been unusual for the man and woman on the street to possess shares and, at the very least, dabble in the markets.

On a global basis, individuals trade stock shares and 'contracts for difference', or CFDs, a share-based product that adds flexibility to an individual's trading options. Whether they are trading shares and CFDs from companies with household names like Tesco or Virgin, or entire indices like the FTSE 100 Index, they put their money to work for them in a more dynamic and intriguing way than depositing it in a bank appears to do. And they do so every day.

And the fact that you're here suggests you want to join in too. This is an ideal place to learn about shares and CFDs, as well as the tools and information you will need to start trading them. So let's get started.

In this first section, we will explain the following to get you on your way to making your first trade:

• What you need to know about shares
• What you need to know about CFDs

Shares - Pieces of a Company

Shares are pieces of a company, with every individual share representing part-ownership. So even if you own just 1 share in a company that has issued 1,000 shares, then you still own 0.1 percent of that company. Likewise if you own just 1 share in a company that has issued 1,000,000 shares, then you own 0.0001 percent of that company.

Companies alone decide how many shares they issue. Traders and other market participants cannot create their own shares and are restricted to trading those shares that the company has issued.

Shareowners are entitled to share in their company's successes and failures, its profits and the losses. When companies make money, the value of their shares usually rises. But, of course, the converse is equally true. Like a marriage, shareholding is for better or worse. Speculation on any share price can drive it up or down in the short term, but a company's performance is really what drives its price in the long term.

Traders buy and sell shares to capitalize on a share's price movement. If a share rises in value whilst you own it, then you make money. So if you bought a Google share (GOOG:xnas) for $400 and then sold it after the price soared to $500 you would make $100 ($500 - $400 = $100).

If you sell a share short (which means you borrow the share from your dealer and sell it on the open market), and the price of that share goes down, you make money. For example, if you borrow a share of Google from your dealer and sell it on the open market for $600, buy it back for $500 and then return it to your dealer, you make $100 ($600 - $500 = $100).

It Is Not Necessarily Just About Making Money

As a shareholder, you are entitled to vote for members of the company's board of directors - and on other issues that are brought before the owners of the company. So you can take a real and proactive interest in its management.

But money is very much what stock trading is about. Companies issue shares to raise money. Very often this is not because they do not already make money but because management sees a potential to generate more product or service if the company has more money to invest. They might, for example, realise that they could easily double production of electroplaters if they had the capacity. If there are plenty of orders, if there is little competition, if the profit margin is good, if demand is anticipated to rise, if such production could easily be managed, then such an investment would probably be sound.

When companies need money, they raise it in two ways. They borrow it from lenders or receive it from investors. The latter don't just give cups of money to companies for nothing. They want something in return. They want pieces of the companies, and by selling shares, companies are able to oblige them.

Publicly-traded companies usually have thousands (and sometimes millions) of individual owners because they ordinarily issue millions of shares and every share has an owner. All of these owners must understand that they share risks as well as profits. As we all know, because the mantra of the Advertising Standards Authority repeatedly warns us of it, the value of investments can fall as well as rise.

The following table illustrates what will happen to the value of your shares based on whether you bought or sold the share to enter your trade:

Share prices fluctuate on a daily basis. Traders must predict the direction they believe a share price is going to move and place their trades accordingly. You will learn more about share analysis and how to anticipate price movements in later sections.

Stock Traders

Stock traders who want to buy or sell a share submit their orders to Saxo, and Saxo takes care of the rest. It really is very simple. The complete process is as follows:

1. You submit an order to Saxo
2. Saxo submits the order to the appropriate stock exchange
3. The exchange fills the order by matching it with another order (or orders)
4. The exchange confirms to Saxo that the order has been filled
5. Saxo updates the order in your account

All of this takes just seconds because Saxo provides a trading platform that enables near-instantaneous order execution for individual investors like yourself.

Re-use of Collateral

Saxo allows up to 60 percent of collateral invested in certain shares and ETFs (Exchange Traded Funds) to be used for margin trading activities (Forex and CFD trading). So if you hold eligible shares worth £20,000 you can re-use up to £12,000 of this as collateral for trading Forex and CFDs.

Contracts for Difference (CFDs)

Contracts for difference (CFDs) bear comparison with the stocks and stock indices on which they are based. But they are beneficial because they give users extra leverage. Whereas stocks are certificates of company ownership, CFDs are simply contracts between two parties (you and your dealer, in most cases) that decide how much money you will make/owe depending on where the price of the underlying stock or stock index moves. So, in a sense, they're like virtual shares.

Whereas there are a limited number of stock shares available for each company, there are no such limits on CFDs. Companies don't issue CFDs or determine how many are available - traders do. Providing there are traders willing to buy or sell CFDs, and dealers or others willing to take the opposite side of the trade (which can mean believing the opposite of what you are convinced will be the case), the number of CFDs you can trade on each share or share index is effectively limitless.

Despite their differences, CFDs and stocks work in much the same way. CFDs alone cannot gain or lose. A stock, on the other hand, can gain or lose all by itself. Yet a CFD attached to a stock share loses or gains in parallel with share. As the share price rises, the CFD moves. Conversely, as the share price falls, the value of the CFD moves.

CFDs and stock shares are like people and hot-air balloons respectively. People cannot fly unaided. Yet balloons fly by themselves. But if you put people inside their baskets, they fly underneath balloons as passengers. As the balloons rise, the passengers also rise. As the balloon descends, the passengers likewise descend.

Every CFD has a specific underlying stock or stock index on which it is based. If you trade a CFD for the Nikkei 225 Index (an index of Japanese stocks that trade on the Tokyo Stock Exchange), for instance, the performance of your CFD is based on the price performance of the Nikkei 225. If you buy the Nikkei 225 CFD and the price of the Nikkei 225 rises, then the value of your CFD will also rise. Conversely, if you sell the Nikkei 225 CFD and the price of the Nikkei 225 moves lower, then the value of your CFD will also move higher.

The following table illustrates what will happen to the value of your CFDs based on whether you bought or sold the CFD to enter your trade and the price movement of the underlying asset:

CFD values fluctuate daily as the price of the underlying asset climbs or falls. Stock traders must determine in which direction underlying assets should move so they can place CFD trades accordingly. You will learn more about how to analyse underlying assets, and predict where prices will go, in later sections.

As an aside, it is perhaps worth mentioning that CFD holders are not entitled to vote for members of the company's board of directors or on other issues that are brought before the owners of the company. CFDs also give you no ownership rights whatsoever in a company.

Along with being quite easy to trade, CFDs enjoy another tremendous advantage over stocks: leverage.

Leverage

CFDs bestow leverage, and leverage is the one characteristic of CFDs that intrigues individual investors the most. Levers employ a small amount of power to achieve a big effect. The physical world is full of levers. Our bones are levers through which we apply force, using muscles, to do everything from tap on a keyboard to land a knockout punch. And CFDs are the stock market's levers. They can sometimes allow traders to use smaller amounts of money to achieve disproportionate gains in the same way that a small child can lift their dad off the ground on a see-saw if both child and dad sit in the right places.

The same principle applies to CFDs. You can make money by simply investing your own money, but you can make much more money if you can use the tool of financial leverage by borrowing money from your dealer. You can also lose more money when trading with leverage.

Incidentally, be warned that, whilst some dealers allow you to use leverage to buy shares on margin, the maximum leverage you can use is limited and not all traders will qualify.

You can lever your CFD accounts, or increase their investing power, by using some of your own money to enter a trade and then borrowing the balance from your dealer. So you might buy or sell a CFD on some popular shares and indices using as little as 10 percent of your own money and borrowing the remaining 90 percent of the price from your dealer.

The leverage employed when trading CFDs is decided by the margin you post for each trade.

Margin

The CFD market proffers exciting possibilities for those traders whose dealers are willing to lend money to enable them to increase the profit-generating potential of all trades. Before your dealer loans money, you will need to show that you have sufficient to cover any and all losses you may incur. This money, set aside by your dealer for safe-keeping, is called margin.

For example, if you bought an Exxon Mobil CFD, you would perhaps be required to set aside 10 percent of the share price as margin. With a share price is $90 you must set aside $9 to prove to your dealer that you can cover losses of at least $9 (a 10 percent loss) should your trade move against you.

But the aforementioned 10 percent margin is a contrived example. Different CFDs have different margins. CFDs corresponding to shares and indices that are actively traded need smaller margins because their high levels of liquidity make it easier to enter and exit trades quickly. Dealers therefore can be confident that they can rapidly close out your positions without incurring unexpected losses if the going gets tough. CFDs covering stocks and indices that are not actively traded need bigger margins since their low levels of liquidity make it harder to enter and exit trades quickly.

Many novice CFD traders often mistakenly believe that the money they set aside as margin is a deposit on stock shares or indices. It is not. They borrow 100 percent of the price from the dealer. The margin only assures the dealer that there is money to cover any losses as they occur.

CFD Financing credit/debit rates

As it is a margined product, you finance the traded value of the CFD with an overnight credit/debit charge. In return for that charge, your dealer is flexible in its lending. When you hold a CFD overnight (e.g. you have an open CFD position at close of market i.e. 17.00 New York time) your CFD position will be subject to the following credit or debit:

• When you hold a long CFD position overnight, you pay interest, meaning that you are debited an amount calculated using the relevant Inter-Bank Offer Rate for the currency in which the underlying share is traded (e.g. LIBOR) plus a mark-up (times Actual Days/360 or Actual Days/365).
• When you hold a short CFD position overnight, you receive interest, meaning that you are credited an amount calculated using the relevant Inter-Bank Bid Rate for the currency in which the underlying share is traded (e.g. LIBID) minus a mark-down (times Actual Days/360 or Actual Days/365).

The credit/debit is calculated on the total nominal value of the underlying share(s) at the time the CFD contract is established (and irrespective of whether it is long or short).

If you open and close a CFD position within one trading day, you are not subject to these credits and/or debits.

CFD Traders

CFD traders who wish to buy or sell CFDs submit their orders to Saxo, and Saxo takes care of the rest. With CFDs, however, Saxo fulfils orders in one of two ways. It either sends the order to a centralized CFD exchange or it acts as the counterparty to the trade.

When you submit an order for a CFD that trades on a centralized exchange, Saxo will handle your order the same way it would handle a stock order viz:

1. You submit an order to Saxo
2. Saxo submits that order to the appropriate exchange
3. The exchange fills the order, matching it with another order (or orders)
4. Saxo receives a confirmation that the order has been filled
5. Saxo updates the order in your account

When you submit an order for a CFD that does not trade on a centralized exchange but is to be fulfilled by Saxo instead, the order process is slightly different, viz:

1. You submit an order to Saxo
2. Saxo fills the order
3. Saxo updates the order in your account

Regardless of the type of CFD you buy or sell, the entire process happens within a matter of seconds. It is virtually identical in that respect to trading a stock.

Short Selling CFDs

The short selling of CFDs directly on exchanges (where Saxo does not market-make) is subject to the rules of the host nation's share market. When trading Australian CFDs, for example, you might find that the volume of CFDs you can short trade in a single day is limited due to limited borrowing availability in the underlying market.

The forced closure of positions if CFDs are recalled can occur. This can easily happen if the share becomes hard to borrow due to takeovers, dividends, rights offerings (and diverse merger and acquisition activities), or due to increased hedge fund selling of the share.

Stock prices can be a roller-coaster ride, and it is this movement that motivates people to trade stocks and CFDs. If stock prices didn't rise and fall, then you couldn't make money trading stocks and CFDs, and you wouldn't be here. And, without traders, much of industry and commerce would be starved of the funds and liquidity they need.

The market is a dynamic environment. Within it, stock prices incessantly move up and down so that they are worth one price at any given moment and yet another price a few seconds later. It may seem random, but stocks invariably move up and down for a reason. And the reason can be anything from an earnings announcement to a whim to a full-blown economic recession. But the root of all reasons is the need to balance the forces of supply and demand. To be successful, you have to pay attention that root of all reasons, but being able to zoom in and focus in minutiae is also extremely useful.

To explain why share prices move up and down in value we will look at the following:

• The forces of supply and demand
• Who is participating in the share and CFD market
• The factors traders look at when pricing a share

Supply and Demand in the Stock and CFD Markets

The forces of supply and demand drive prices. Supply is driven by the number of stocks or CFDs available to the investing public. Demand is driven by the wish of traders to buy or sell a stock or CFD.

Here you can see a typical supply and demand chart (see Figure 1). Demand is represented by the line sloping downward from left to right, whilst supply is represented by the line sloping upward from right to left. The intersection of these two lines represents the price the market will accept for the stock or CFD.

Figure 1-Supply and Demand Chart

Supply and demand can both fluctuate according to sundry market conditions. We are going to examine how movements in either supply or demand can influence the value of a stock or CFD as follows:

• Increasing demand
• Increasing supply
• Decreasing demand
• Decreasing supply

How Increasing Demand Affects Stock and CFD Values

Increasing demand for a stock or CFD pushes up its value.

On the supply and demand chart below (see Figure 2) it is evident that, when demand increases, the demand curve shifts to the right. As it does so, the point at which it intersects with the supply curve moves higher. This shows that increasing demand for a stock or CFD increases its value too.

Figure 2-Supply and Demand Chart (Increased Demand)

Demand for stocks and CFDs can increase when companies announce better-than-expected earnings for a quarter or the year. When Apple Inc. (AAPL:xnas) announced an earnings boost due to frenetic buying of its iPod, traders bought Apple shares in the hope that the company would have a record year and that Apple stock values and premiums would reflect that.

Unlike Apple and the iPod, market crazes are often due to surreal increases in demand that have little if anything to do with the true value of the product or service involved. A famous example is the Dutch Tulip Mania. Traders returning from the Ottoman Empire introduced tulips to Holland in the late 16th century. By the early 17 th century, tulips, and especially rare bulbs, were trading at ludicrous prices. The most expensive recorded sale was 6,000 florins for a Semper Augustus bulb. To put this in perspective, the average annual income at the time was 150 florins. That means 40 years' work would earn you a tulip bulb at a time when the average life expectancy certainly didn't accommodate 40 years' work. Assumedly, tulip brokers didn't dream of retiring to a country pile in Surrey but fantasized instead about retiring with their little black tulip. The irony is that, as anyone who has ever worked with bulbs would tell you, it is terribly hard to determine one tulip bulb from another (or, indeed, from daffodil bulbs). So it's difficult to fathom why anyone would sacrifice all for a little black bulb that's not discernibly better than its rivals. Never underestimate the effect of increasing demand.

How Increasing Supply Affects Stock and CFD Values

Increasing supply of a share or CFD decreases its value.

On the supply and demand chart below (see Figure 3) you can see that as supply increases the supply curve moves to the right. As it does the intersection with the demand curve moves down. Consequently increasing supply of a stock or CFD reduces its value.

Figure 3-Supply and Demand Chart (Increased Supply)

Supply of a stock or CFD can increase when a major share-market index delists a share. For example industrial supply manufacturer Honeywell (HON:xnys) used to be a component of the Dow Jones Industrial Average. As economic conditions made Honeywell a less significant share in the broader market the Dow Jones delisted it from its premier index. As a result of this delisting many fund managers who maintain portfolios based on the Dow Jones Industrial Average were forced to sell their Honeywell shares, increasing the supply for sale in the market and thus eroding the share price.

How Decreasing Demand Affects Stock and CFD Values

Decreasing demand for a sstock or CFD decreases its value.

On the supply and demand chart below (see Figure 4) you can see that as demand decreases the demand curve moves left. As it does so the intersection with the supply curve moves lower, showing that increasing demand for a stock or CFD decreases its value.

Figure 4-Supply and Demand Chart (Decreased Demand)

Demand for a stock or CFD can slump if traders hear bad news or rumours about a company. For instance in 2004 the international pharmaceutical manufacturer Merck & Co. (MRK:xnys) withdraw its arthritis drug Vioxx amidst claims of increased coronary risk for users. Trader concern over loss of revenue and the likelihood of a class action dramatically undermined Merck's profitability, and their stock value plummeted.

How Decreasing Supply Affects Stock and CFD Values

Decreasing supply of a share or CFD increases the value of that stock or CFD.

The supply and demand chart below (see Figure 5) shows that as supply decreases the supply curve moves to the left. As it does so, the intersection of the demand and supply curves moves higher. This proves that restricting the supply of a stock or CFD increases its value.

Figure 5-Supply and Demand Chart (Decreased Supply)

Stock or CFD supply slumps as companies buy back shares. Cash-rich companies that feel their stock is underpriced often buy their own stock shares to drive up the price and therefore increase inward investment.

In summary, changes in supply and demand can affect stock and CFD prices. But no doubt you are asking what causes those changes in supply and demand. We shall explain.

Stock and CFD Market Participants

Stock and CFD markets could be compared with the Tower of Babel . Traders represent every ethnicity, every culture and every language. But all of these people must recognize, if they are to survive for long, the forces of supply and demand. Yet every participant has a personal agenda and individual needs. Some look for quick profits whilst others take a long-term view. Some have zillions to invest while others barely have enough to meet account minimums. You will never understand what is going on in every trader's head. Yet broadly understanding their motivations can help you to anticipate market developments and enable you to outperform it. And that is the key. Outperform the market, and you should be in marked profit.

For the purposes of this discussion, we will divide the major market participants into two groups:

• Institutional investors
• Individual investors

Institutional investors are substantial professionals who typically control huge sums of money and involve themselves in mutual funds, hedge funds, pension funds and so forth. Being so influential, you should focus on them when trying to decode the market.

Individual investors are people like you who either trade for a living or as a sideline to boost income and net worth. This group should play a less significant role in your analysis.

Institutional investors drive markets. Having so much money in their portfolios, they are a potent influence on the market and its prices. Their ability as traders to buy shares in huge volumes will invariably drive prices more than traders who dabble ever could.

Institutional investors largely operate under strict mandates, they observe certain trading rules and they invest in specific classes of assets. For example some institutional investors only operate funds that are known as large-cap funds. This means that they exclusively contain shares in companies with a market capitalization exceeding $5 billion. Meanwhile other institutional investors stick to technology funds so they buy shares in technology-based companies such as Microsoft (MSFT:xnas) or Google (GOOG:xnas). Others operate only with ethical or green or fair-trade funds.

As an aside, and since we mentioned market capitalization, it equates the number of shares issued multiplied by the price per share. For example, General Electric (GE:xnys) has nearly 9.99 billion shares and a share price (at the time of writing) of $32.23. This gives the company a market cap (or capitalization) of more than $321 billion (i.e. 9.99 billion × $32.23 = $321+ billion).

Divining what institutional traders are doing with their portfolios enables you to determine how the forces of supply and demand are acting - and how those dynamics are going to influence stock prices. You are never going to know exactly what these institutional traders are doing. Certainly you would have to be privy to their deals to know. Yet, if you know what they are watching when they make their decisions, you can watch the same things and intelligently deduce what they might do next.

Factors that Affect Stock Prices

Many different factors influence stock prices. A handful of key factors play important roles in determining stock values, and the following are the four factors you should observe most closely:

• Earnings and other fundamentals
• Dividends
• Economic announcements
• General shifts in market/sector strength

Earnings and Other Fundamental Numbers

It is largely company performance that drives share prices. If you buy a stock, then you buy a slice of the company, a slice of its successes and failures. A company that performs well attracts more interest in its shares. Interest translates to demand, and demand translates into higher prices. The converse is true for a company that performs disappointingly.

To determine company performance, traders and analysts examine several fundamental figures (i.e. numbers derived from a company's balance sheet and income statement). A company's earnings - the amount it makes after paying its expenses - is typically the most important of these. Yet there are other fundamental numbers such as the return on equity (ROE) and the price-to-book ratio that present traders with an indication of the overall health of a company. There will be more about company fundamentals later.

Dividends

Companies can do two things with profits: they can keep and reinvest them or they can pay shareholders a dividend. Dividends are per-share payments so if a company with 1,000,000 shares issued pays a £5,000,000 dividend, each share receives £5.

Traders value dividends highly because, assuming the shares are held for a time, they represent regular cash returns on investments. Since dividends are prized, a company can boost share value by boosting its dividend (though investors will want to see that the company can afford this generosity). Companies increasing dividends generally enjoy stock-price increases, whilst the converse is equally true. Despite this, fewer companies pay dividends nowadays and instead retain earnings to reinvest in the company. In such cases, an investor who needs regular income is forced to sell at least some shares or invest, instead, in companies that do generate dividends.

Depending on whether you are a share or CFD trader, Saxo treats company dividends differently.

Dividends on Stock Positions

Saxo credits dividend payments on share positions to your account with any applicable standard withholding taxes deducted. For obvious reasons, Saxo cannot currently support or offer preferential withholding tax rates that may be available due to residency or legal status.

Dividends on CFD Positions

When dividends are paid on underlying shares, holders of long CFD positions qualify for proportional payouts. Holders of short CFD positions have to pay an amount equal to the full (gross) dividend paid on underlying shares.

All cash dividends for CFD positions are settled on pay date. Cash dividends are booked on ex-date to reflect market price movements on the ex-date, but the actual value of the payment is settled on pay date.

Dividends on CFD positions are cash adjustments paid or debited by Saxo and not by the underlying company. Dividends paid on CFDs are not eligible for any preferential withholding tax rates sometimes associated with dividends paid on physical shares, so may differ from the dividends payable on underlying shares.

Dividends on Index Trackers

When underlying shares that are part of Index CFDs go ex-dividend, the Index CFD prices are adjusted to reflect dividends. The weighted proportion of the dividends within the Index are credited to client accounts for long positions and debited for short.

Note that the DAX30 is a Total Return Index, so the index is automatically adjusted for dividends.

Index Dividend = Share Dividend * Shares in index / Index Divisor*.

* Divisor: the amount used to stabilize the index value when its composition changes. The sum of all index members' prices is divided by the divisor to achieve the normalized index value. The divisor is adjusted when capitalization amendments are made to the index members, allowing the index value to remain comparable at all times. To prevent the value of an index from changing due to such events, all corporate actions affecting market capitalization of the index require divisor adjustment to ensure the index values remain unaffected by the event.

Economic Announcements

Economic announcements, usually released by governments and other large groups, include interest rates and gross domestic product (GDP). They often affect the economy as a whole, not just individual companies. Such news may well be important to you as a stock and CFD trader, but you should not miss it because it is scheduled months in advance. Traders know a year in advance when the U.S. Federal Open Market Committee (FOMC) will meet to discuss interest rate changes. Likewise in the UK , the government's budgets and mini-budgets are scheduled well ahead of the actual events. This gives you plenty of time to research the likely content of announcements and position your portfolio accordingly.

Fortunately for you, Saxo provides an up-to-the-minute economic calendar so you can know exactly what news is scheduled for release today, tomorrow and into the future (see Figure 1).

Figure 6-Economic Calendar

A cursory glance at the calendar tells you about upcoming events that have the potential to influence the movement of the stocks and CFDs you are watching. These events might include announcements involving German unemployment data, U.K. money supply and U.S. gross domestic product (GDP), as is demonstrated by the figure above.

Investment analysts, economists and other market participants constantly analyse these announcements, trying to second-guess their content. Analysts seldom agree, but the body of opinion produces what is called the "consensus estimate" and is broadly reliable.

Familiarity with the consensus estimate lets traders take advantage of price movements once the economic announcement is released because the consensus estimate will already be "priced in" to the value of the stocks and CFDs. Investors will have placed trades before the announcement to take advantage of where they believe stocks and CFDs will move. If the economic announcement matches the consensus estimate, then prices will barely move because most institutional investors have already placed their trades. It is only really when the consensus estimate has been inaccurate because the market is wrong-footed that prices have to adjust to accommodate the new economic realities. At such a time, when market participants are scrambling to factor in the new information, you will have opportunities to capitalise on price movement. Yes this is flagrant opportunism, but that should become second nature.

General Shifts in Market/Sector Strength

Companies prefer their stock price to reflect their individual corporate performance, yet other general market forces can lift or lower share values regardless of that performance.

There's an old adage that every trader ought to know: "A rising tide floats all boats." Simply put, it means that in a bullish market most stocks go up because the market and the economy in general are going up. On the other hand, it means that in a bearish market, most shares go down because the market and the economy in general are going down.

This truism may apply to the market in general but not necessarily to certain sectors of it. For instance, healthcare stocks may be booming but retail shares may be slumping. Bullish and bearish forces within individual sectors can have the same impact on the stocks within those sectors as bullish and bearish forces can have on the overall market. Nothing is set in stone.

We will tell you more about the analysis of market and sector trends in a later section. Right now simply knowing that these forces exist will put you well ahead of most retail traders.

Stocks are eternally rising and falling. Financial reports tell of stocks moving up and down. They are, of course, referring to prices. Stock prices change daily and fortunes rest on the ability to predict such changes. Your job as a stock or CFD trader is to learn to identify where the prices of actual or potential investments are going to go next.

Stock and CFD traders track historical prices using price charts. By keeping track of historical prices, traders are able to more accurately project where prices are likely to head in the future. The process of analyzing historical prices to intelligently predict future price movement is called technical analysis.

Technical analysis, or chart reading, is the natural progression after you have conducted your fundamental analysis. Fundamental analysis helps you determine whether you should buy or sell a particular stock or CFD. Technical analysis helps you determine when you should buy or sell that stock or CFD.

Despite the science and math behind it, technical analysis is considered by most traders to be almost an art form which takes time and practice to master. It may seem complex, but technical analysis is indispensable to good trading, and the fundamentals are reasonably simple:

• Trends–where prices may be going
• Support and Resistance–where prices may stop and turn around

Trading with the Trend

Identifying trends and trading intelligently with them in mind is vital to your success as a stock or CFD trader. Traders are gregarious, and when one or two identify an opportunity or a threat, the others typically follow suit to push the price in the same direction. Once a stock has achieved some momentum, it is likely to be sustained for a while. Spotting such a trend will increase your likelihood of making money (or not losing it, which is equally important). Bucking a trend generally turns out to be a loss-making proposition.

Trends indicate where prices will probably head in the future. If traders push a price higher, then you ought to buy to make money. If traders push a price lower, then you ought to sell to prevent losses. If traders disagree over a price, then you could alternate between buying and selling, or you could wait until a clear trend emerges, then ride it.

Trends are not entirely linear. Prices rarely move straight up or straight down. Movements are always a little fuzzy because of the many individuals who are trading, and because they are largely trading in idiosyncratic ways. Yet there is a herd mentality. When a majority of traders believes the stock price is going to move in one direction, they can overpower the minority of traders who disagree with them. When this occurs, the price begins to trend and will usually move in one direction for a while until the majority loses confidence – which is reflected in reduced momentum. At that point, the minority can momentarily exert its influence and push the stock price in the opposite direction. And so on. It is a little like rugby.

Like in rugby, there are turning-points is price trends. There are moments when the application of huge amounts of force may achieve nothing, and therefore the effort is wasted, just as there are moments when a smaller and well-timed effort can achieve spectacular results. Trading is very much an activity in which timing is critical. Learning to identify the critical moments as a trader, the moments when a price will soar or plummet to create an opportunity, all hinges on the recognition of upward and downward trends.

Upward trends - stocks or CFDs that are upward trending form a series of higher highs and higher lows (see Figure 1).

Figure 1–Up Trend

Down trends - stocks or CFDs that are trending downward form a series of lower highs and lower lows (see Figure 2).

Figure 2–Down Trend

Sideways trends - stocks or CFDs that are trending sideways form a series of highs that are at approximately the same price level and a series of lows that are at approximately the same price level (see Figure 3).

Figure 3–Sideways Trend

Trends–whether they are upward trends, downward trends or sideways trends–can become immediately apparent or take a while to spot. Identifying the following trends over each time-frame and being able to utilise them will be crucial to your success as a stock or CFD trader:

• Long-term trends
• Intermediate trends
• Short-term trends
• Aligning trend time-frames

Long-Term Trend

Fundamental factors are the major drivers of long-term trends. If companies perform fundamentally well, their stock prices typically rise. If companies perform fundamentally poorly, their stock prices typically fall. Whilst the outlook for a company can literally change overnight, the trends established by a company's fundamental strength or weakness tend to last for a while.

Long-term trends, sometimes called major trends, are those trends that have dominated a stock or CFD for the longest period. Looking at this weekly chart of McDonalds (MCD:xnys), you will notice that the price has steadily risen in an upward trend, which runs from left to right. Notice the series of higher highs and higher lows as time progressed (see Figure 4).

Figure 4–Long-Term Trend

When you see a strong upward trend, like that on the McDonalds chart, you know that traders are keen to invest in its stock, and you should consider doing the same if you want to make money. If the trend on the McDonalds chart had been downward, you would then have been advised to consider selling to take advantage of the price movement.

Next, you ought to examine an intermediate trend to see if it is heading in the same direction as the long-term trend.

Intermediate Trend

Intermediate trends, sometimes called minor trends, move more quickly than long-term trends because they do not last for so long. These trends are also affected by a company's fundamental factors. As the daily McDonalds chart shows, the price has not moved straight up but has followed a long-term upward trend. At times, the intermediate trend has seen the price move sideways, and at times it has fallen, but the overriding trend is clearly upwards (see Figure 5).

Figure 5–Intermediate Trend

Notice that, whilst there have been periods when the intermediate trend was moving both sideways and downward, the long-term trend was still upwards. Trends tend to move in a stepped fashion. Rarely do they move straight up or straight down.

Seeing this price trend should motivate you to buy McDonalds. You would then be bullish since you would anticipate that the price would continue to rise. But you might want to wait to buy when you saw the intermediate trend move upward-and in line with the long-term trend.

Next, you should look at the short-term trend to see if it is heading in the same direction as the long-term and intermediate trends.

Short-Term Trend

Short-term trends, sometimes called micro trends, are more volatile than both long-term and intermediate trends because they cover the shortest period of time and are driven by the news of the day. Often, these short-term trends rapidly reverse. Looking at the McDonalds hourly chart you can see that the price was initially on a short-term downward trend. Notice the series of lower highs and lower lows as time progressed (see Figure 6).

Figure 6–Short-Term Trend

Notice that, whilst the short-term trend was downward, the intermediate and long-term trends were upward. So it is possible to have trend time-frames simultaneously moving in different directions.

Seeing this downward trend on the hourly chart would probably have prevented you from bullishly investing in McDonalds at that time, even though the intermediate and long-term trends were bullish. However, since it is the only the short-term trend that might undermine confidence, you should still be bullish about McDonalds.

In fact, if you look at the end of the hourly chart for McDonalds, you can see that the short-term trend is changing direction and that this change could soon align the short-term, intermediate and long-term trends in a way which should encourage you to buy.

Aligning Trend Time-frames

Your most profitable trading opportunities will come when the long-term, intermediate and short-term trends all line up in the same direction. Just as it is easier to swim downstream instead of upstream against the current, it is easier to trade with a trend than against it. When long-term, intermediate and short-term trends all rise in unison, it is an ideal time to buy a stock or CFD. When long-term, intermediate and short-term trends all fall in unison, it is an excellent time to sell.

The McDonalds chart shows that the trend for each time-frame has risen for the past few months, during which the price has soared. Had you invested in the company throughout this time, it would have been very profitable for you (see Figure 7).

Figure 7–Aligning Various Trend Timeframes

Understanding trends is critical to technical analysis. Yet, you also have to understand the concepts of support and resistance.

Paying Attention to Support and Resistance

Support and resistance levels are like the ends of an Olympic swimming pool. Just as the ends of the pool force swimmers to turn and swim in the opposite direction, support and resistance levels tell traders that the price of a stock or CFD is likely to stop moving, to turn around and to start moving in the opposite direction. Knowing when such a reversal should occur helps traders to buy and sell at the most profitable times.

Support is a price level at which a currency pair tends to stop falling, turns around and starts climbing again. Support usually occurs because of the following:

• Traders who missed an earlier buying opportunity decide it is a good time to invest
• Traders who bought the stock or CFD decide it is a good time to add to their positions
• Traders who sold the stock or CFD decide it is a good time to take profits

Resistance is a price level at which a currency pair tends to stop rising, turns around and starts falling again. Resistance usually occurs because of the following:

• Traders who missed an earlier selling opportunity decide it is a good time to trade
• Traders who sold the stock or CFD decide it is a good time to add to their positions
• Traders who bought the stock or CFD decide it is a good time to take profits

Support and resistance levels are not precise. You could compare them with soft buffers or crash barriers. They are the vague limits at which traders say 'they cannot be worth so much; I'm selling' or 'they cannot be worth so little; I'm buying.' You would only frustrate yourself trying to pinpoint a price level of 1410 on the S&P 500 as the ideal time to support. Instead you would be much better off identifying a price range of 1400 to 1420, or 1390 to 1430, as support. So support and resistance levels should be flexible.

There are different types of support and resistance levels, and you will need to learn to recognize the following:

• Horizontal support and resistance
• Diagonal support and resistance

Horizontal Support and Resistance

Horizontal support and resistance levels form as prices rise or fall. You can see these support and resistance levels take shape on charts which track the stocks and CFDs that you are interested in trading.

On the Caterpillar (CAT:xnys) chart, for instance, you can see that certain price levels (indicated by bold black lines) acted as strong levels of support and resistance. From June 2007 until the early part of August 2007, the $77.50 price level served as support for the stock (see Figure 8). This same price level, once the stock tumbled down through it in mid-August, served as resistance to the price rising through the rest of August and into September.

Figure 8–Horizontal Support and Resistance

If you had bought into Caterpillar in early September at $72.50 as it was bouncing off the support level, and it was now nearing $82.50, you might well think of selling. Previously, this price had marked a significant resistance level. Consequently the price might now turn around and move lower.

Once you can confidently identify horizontal levels of support and resistance, you can move on to diagonal levels of the same.

Diagonal Support and Resistance

Diagonal support and resistance levels can be invaluable to a trader. Whilst these levels can be more difficult to identify for novices, they are invaluable for analyzing a trend. Remember it is much easier to make profitable trades when a stock or CFD is in a trend.

As you look at the charts of the stocks and CFDs you will notice that they often form higher highs and higher lows (or lower highs and lower lows) as their fortunes wax and wane. The lines connecting these highs and lows are diagonal support and resistance levels.

Examine the Caterpillar (CAT:xnys) chart again. You can see that the price hit a series of lower highs and lower lows toward the end of 2007. If you connect all of the highs with one diagonal line and all of the lows with another diagonal line (indicated by bold black lines) you will be able to see the diagonal levels of support and resistance that drove Caterpillar's price (see Figure 9).

You can also see that a downward trend level between the support and resistance levels served as both support and resistance during this same time period.

Figure 9–Diagonal Support and Resistance

If you were to invest in Caterpillar, you would most likely wait until you saw the price rise to the downward trending resistance level before you would sell and take your profits.

The knack of effectively investing using support and resistance levels is to combine both horizontal and diagonal levels in your analysis. As is apparent from these illustrations of Caterpillar's price chart, such levels co-exist and interact. In conclusion, your stock and CFD charts have a wealth of information locked within them, and they are waiting for you to unlock that information with simple-but-effective technical analysis techniques.

Wise inve stment necessarily involves money management. Money management involves spreading your risk appropriately across your portfolio. If you capably manage your money, you can trade successfully for years, but ineptitude in the long or short term could wipe out any fortune you have.

Trading in stocks and CFDs is invariably compared with poker, and clearly some of the skills are transferable. Both require astute money management to be successful in the long term. Both are activities in which an ability to collate, retain and use information will increase the odds of a win. But, of course, poker is very much about the perceptions of opponents-while in trading, you will find yourself unable to bluff the market.

The investors who tend to enjoy the greatest sustained success are those who stick to predetermined, clearly defined rules. These rules help them to avoid major crises.

We will look at three money management rules you need to incorporate in your trading:

• Live to trade another day
• Know what you are willing to risk
• Know how to determine trade size

You will also learn about one of the stock and CFD market's most important trading tools: the so-called 'stop-loss.'

Live to Trade Another Day

Living to trade another day is perhaps the most important goal. Regardless of whether you make bad decisions during any trading period, if you live to trade another day, you will have a chance to recoup losses and ultimately achieve success. The common-sense rules we suggest that you impose on your trading will enable you to survive everything that the stock and CFD market throws at you. If you understand and observe these rules, you will already have an advantage over most investors. That advantage means you should, of course, not only survive but outperform the market.

The single factor that causes most investors to overextend themselves and suffer catastrophic losses is greed. Greedy investors take unnecessary risks. Typically they will fool themselves that a single indicator is the absolute key to success. You could draw a parallel with those who bet on horses using the formula that the next stake has to be sufficient to potentially wipe out any previous losses. Clearly such a strategy can only work if the gambler is wise enough to quit whilst he is ahead and does not run out of the necessary funds, the amount he needs to wipe out previous losses, first. Of course, such a gambler, when he is left with a reduced stake, can only recoup all of his losses by gambling at longer odds. Those longer odds reflect the likely chances of success. So the risks become increasingly acute, and the apparent necessity to gamble all that is left means ever-increasing risk. This is the kind of desperation which traders need to avoid.

Unfortunately, there is no secret to sure-fire gains in the markets-just like there is that a race-goer will beat the turf accountants. Most traders have confidence in specific indicators. Many focus on particular markets and hope that this focus, and the quantitative or qualitative data they collect, will prove to be the key to investment success. But markets are dynamic and essentially volatile. In such an environment there are no cast-iron certainties. To help you avoid a roller-coaster ride, we are going to show you how to live to trade another day so that, no matter what changes take place in the market, you can enjoy at least modest and worthwhile success.

Know What You Are Willing to Risk

Know what you are willing to risk before you ever enter a trade is the basic tenet of living to trade another day. If you do not risk too high a proportion of your funds in any one trade, or in a handful of trades, then you will be able to continue trading whatever the outcome of your trades. In other words, it is not sound investment practice to put too many eggs in one basket.

You will have to decide what percentage of your account you are willing to lose in any one trade. Once you have decided that, the rest is simple math. Most investors feel comfortable risking approximately 2 percent of their total account balance in any one trade. This is a general rule of thumb, but it is up to you to decide how aggressive or conservative you want to be. If you want to be more aggressive, you could risk a larger percentage of your account in any one trade. If you want to be more conservative, you could risk a smaller percentage of your account in any one trade. It is up to you to determine how much you are willing to risk.

Once you have decided what percentage of your account you are happy to risk, all you have to do is enter that value into the following equation:

Account balance × risk percentage = amount at risk

The math is simple. Imagine that you have an account balance of £50,000 and would like to risk 2 percent of your account in any one trade. If you drop these numbers into the equation, you will see you should not risk more than £1,000 in any one trade.

£50,000 ­× 0.02 = £1,000

Clearly, the same math works even if you want to invest in dollars or euros.

Remember that this is the maximum amount to risk in any single trade. You may have much more at risk if you are simultaneously involved in other investments. If you were in five trades at once, for example, you would risk only £1,000 per trade but have a total amount at risk of £5,000. Once you decide how much you are willing to risk, you are ready to determine your trade size.

What we should emphasize at this point is that you ought to consider every penny of your investment to be at risk of a total loss-unless you have a 'stop-loss' (something we are going to explain, but essentially it means a limit at which you would definitely sell an investment that was losing money and cut your losses).

Know How to Determine Trade Size

You need to know how to determine trade size to prevent unnecessary exposure to risk. Trade size is the volume of stocks or CFDs you buy or sell in any individual transaction. Once you know how much you are willing to risk, you need to know how to set up your trades so that you do not risk more than you are comfortable with. It is pointless deciding what risks you will tolerate but then, for whatever reason, entering a transaction that exposes you to too much risk.

To determine your trade size, you must first decide where you are going to set your stop-loss. Once you have decided where to place the stop-loss, you have to calculate the difference between that price point and the point where you enter the trade. Then all you have to do is enter that difference into another simple equation.

Amount at risk ÷ distance between entry price and stop-loss price = size of your trade

e.g. £1,000 ÷ (£,1000 - £700) = £300

The size of your trade is now, in effect, not the whole amount invested but the part of it which is at risk between your entry point and the stop-loss.

Knowing exactly how to size your trade will help you eliminate the nightmare scenario-one where you could lose more than you are comfortable losing, and perhaps even lose everything in that stock or CFD. Using a stop loss you will make investing much less stressful, and the presence of such boundaries will increase the likelihood of you making an overall profit on your trading rather than a loss.

Stop-Loss Orders

A stop-loss order is an order you place with your dealer to sell if the stock or CFD reaches a predetermined price point. Stop-loss orders allow you to automatically protect your trading account even in your absence-i.e. when you are not in front of your computer. This is essential since most traders cannot watch their investments 24/7.

If you buy a stock or CFD, you should always place a stop-loss order somewhere below the current price. This will protect you if the stock or CFD loses value.

If you sell a stock or CFD to enter your trade, you should always place a stop-loss order somewhere above the current price. This will protect you if the stock or CFD uexpectedly increases in value.

We will give you an example. Imagine you buy 50 shares of General Electric (GE:xnys) stock at $35. You know that there is strong support approximately $5 below this price level at $30. You therefore decide that if GE falls below this $30 level, it may continue lower. To protect your investment, you set a stop-loss order with your dealer at $30. If the price of GE drops to $30, even momentarily, at any time during the trading day, your dealer will automatically sell your stock for you.

Stop-loss orders provide safety and security when you are trading, and they ought to play a critical role in all of your money-management decisions. You should never place a trade without one.

Lastly, we ought to explain a more sophisticated type of stop-loss order. When you have a little confidence in the use of ordinary stop-loss orders, you could experiment with trailing stop-losses. These move as the price of the stock or CFD moves. You can set a trailing stop-loss to trail the price of the stock or CFD by £5, for instance.

You might buy at £35 and initially set your trailing stop-loss at £30. Then, if the price rose to £40, your trailing stop-loss would automatically rise to £35 (i.e. £5 below the highest price the stock or CFD reached). If the stock or CFD then suffered a reversal and fell back to £35, your stop-loss level of £35 would trigger the stock's sale.