Contract For Differences (CFD) – Chapter 11: Other Types of Orders

Limit order:

This is an order which instructs the brokerage firm to purchase or sell a fixed quantity of shares at a price specified by the trader. This type of order also permits an investor to limit the time frame of the order to go unexecuted before being disregarded.

A limit order can either be a buy limit order or sell limit order. This depends on what position the trader is holding. Sell limit orders are usually applicable for a long position whereas a buy limit order is typically used for shorting a position.

Although limit orders are more costly than market orders, they have the distinct advantage of letting the trader achieving a specific price level. This is particularly useful for scenarios where the volume traded is low or extremely volatile.

Stop order:

This is an order to purchase or dispose of an asset once its price has breached a particular point defined by the trader. The two main purposes of this type of order is to:
Lock in a trader’s profit
Limit the loss of the trader

Once the price has breached the predefined threshold, an exit or entry point, the stop order becomes a market order to buy or sell. This type of order is also commonly known as “Stop” or “Stop loss order”.

This trading strategy is normally employed by traders when they are unable to monitor their investments for a prolonged period of time. It is to be noted that “Stops” are not a one hundred percent guarantee of obtaining the predefined entry or exit point. In cases where a share gaps down, the Stop will be put into effect at substantially lower than the expected price.

Those who are familiar with technical analysis will be able to place their Stops at key levels defined by simple moving averages, trend lines and other technical indicators.

Trading By the Pair:

CFDs are also a great tool for pairing trading strategy. For example, you believe that Pepsi is undervalued in contrast to Coca Cola. In this scenario, you can adopt a pairing strategy by going short on the costlier of the two stocks and at the same time, going long on the cheaper of the two stocks.

Tax Efficient Trading:

If you have an investment portfolio of actual shares of a company, you can sell CFDs backed by these shares without having to crystallize a taxable capital gain tax gains. This permits you to decide when exactly that you wish without having to close your market position thus reducing the taxable gains.