What is CFD trading?
A Contract for Difference (or CFD) is an agreement between two parties to pay the difference between the underlying asset’s current price and its price when the trade is closed. It essentially allows traders to trade the direction of CFD’s products such as Forex, Shares, Indices, and Commodities in a specific time period. Trading CFDs means that you can either make a profit or a loss, depending on which direction your chosen
There are several key features of CFDs that make them a unique and exciting product:
- CFDs are a derivatives product
- CFDs are leveraged
- You can profit and incur losses from both rising and falling prices
What are the derivatives products:
Contracts For Difference (CFDs) financial derivative products which enable investors to trade on the price movement of financial instruments from shares, indices to Commodities and Currencies.
We make it more clear by giving an example. Say, you would like to buy 5000 shares of Apple company at the price of $120, so the total investment would cost you $6,00,000. For this transaction, you will receive the ownership of the shares in the forms stock certificates.
With CFDs however, you don’t own those Apple shares. You’re simply speculating, and potentially profiting, from the same movements in share price.
WHY CFDs are Leveraged?
Investors are attracted to CFDs because of the leveraged opportunities they offer, the low initial capital required to commence trading. The important thing to remember about leverage, however, because CFDs benefit from leverage, these losses can be more extreme when compared to your initial investment. With an investment of 5,000 euros you can gain 50,000 euros, but you can also lose the same amount.
So if prices move against you, you may be closed out of your position by a margin call or have to top up your funds to keep it open – so it’s important to understand how to manage your risk. .
How does CFD trading work?
With CFD trading, you don’t buy or sell the underlying asset (for example a physical share, currency pair or commodity). You buy or sell a number of units for a particular instrument depending on whether you think prices will go up or down.
For every point the price of the instrument moves in your favour, you gain multiples of the number of CFD units you have bought or sold. For every point the price moves against you, you will make a loss.
To do this, you will need:
- To open a trading account with a CFD broker.
- To download that broker’s CFD software, or platform.
- To choose an asset you would like to trade.
- To decide whether you think that asset’s price will go up or down.
For example, you bought 100 Apple Share CFD @ $120 and then sold it at $125 after a few months. So, what was your profit for this trade?. It should be (($120-$125)*100) = $500. This is known as a ‘long’ trade. Alternatively, If you thought the price of apple share was going to fall, you could open a ‘sell’ trade in your trading platform. This is known as a ‘short’ trade, and it means you open a trade expecting the price of an asset to fall, and then close the trade (or ‘buy’ the asset back) and make a profit on the difference.
For example, if you opened a sell-trade of 100 Apple Share CFD @ $120 and after a few months the price was down to $ 115. So, what was your profit for this trade?. It should be (($120-$115)*100) = $500
However, if your expectation and analysis was wrong, it would be your potential loss. For example, you bought 100 Apple Share CFD @ $120 expecting that the price will move to $125. However, the market was down instead of going up and the price hit to $115. So, you incurred a loss of $500 for this long or buy trade.
Types of CFD:
FOREX CFD INSTRUMENTS
Most popular Forex CFDs include:
- The EUR/USD
- The GBP/USD
- The USD/JPY
- The EUR/GBP
Some of the most popular share CFDs include:
- The DAX30 CFD
- The DJI30 CFD (representing the Dow Jones)
- The FTSE100 CFD
- The NQ100 CFD (representing the Nasdaq100 index)
Some of the most popular commodity CFDs are:
- Spot gold share CFDs
- Spot silver CFDs
- Brent crude oil CFDs
- WTI crude oil CFDs
What major trading risks of trading CFDs?
Remember that all forms of trading involve risk, but dealing with derivatives can be trickier for trading newbies. Make sure to check with your local regulatory bodies to see their policies on CFD trading.
Also, don’t forget to read your broker’s terms regarding leverage, commissions, rollover computations, and other transaction costs. Once you’ve found a good CFD broker and tried out their demo accounts, then you’re on your way to expanding your trading basket and your trading skill set!
Next lesson: Some basic trading terminology for the first time in trading.
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