CFD stands for Contract for Difference, and it is an agreement that is held between two parties. In this agreement, the aim is to exchange differences between the opening and closing price of a contract. This type of trading offers incredible flexibility making it possible to trade in more than 400 markets across the globe.
With traditional trading, one may decide how to trade based on factual information from the markets. With CFD trading, speculation takes center stage over a range of commodities. These including shares, indices and currencies. One can choose to speculate on the price movement and then trade whether the prices are falling or rising. As you are speculating, you do not need to worry about finally owning the underlying instrument. This means that you can enjoy all the benefits, without needing to take too much responsibility.
CFD Trading Products
When you start trading with CFDs, you will typically have the option of three main types of products available for online trade. These include: –
- Shares – It is possible to invest in large and thriving companies such as Google and Facebook, without having to actually own shares if you are trading with CFDs. This way, you can benefit from profit in the event that the value of these shares continues growing.
- Indices – When you need to keep track and measure performance of a certain group of stocks within a specified stock exchange, then you will access an index. CFD trading makes it possible to gain access to the best indices around the world, including NASDAQ and Nikkei.
- Commodities – There are commodities that people typically buy which you can benefit from without purchasing through trading CFDs. Some of these commodities including gold, oil, coffee, silver, platinum and more.
CFD trading and Leverage
CFD is defined as a leveraged product. This means that all you need to do is make a deposit that is a small percentage of the entire value of the trade. This is how you open a position. Then there is trading on margin which is the leverage in practice. It makes it possible for you to magnify your returns, though it is worth noting that the same could apply to your losses as well. When you are trading traditionally the broker needs to receive the full value of the asset that you are looking to purchase with payment, and you also need to factor in the commission and additional fees that you will be asked to pay for that transaction.
How CFD Trading Works
Making profit from both rising and falling markets can seem extraordinary, yet it works well with CFDs and here is how.
If you are of the opinion the price of an asset is going to go up, you can choose to buy which is also known as going long. This will make it possible for you to benefit from the increase. If you are of the opinion that the price of an asset is going to fall, then you choose to sell which is also known as going short. This will mean that you will get a profit each time that the price of the asset drops, When the markets do not go according to what you expect, then you will make a loss.
Why trading CFD’s?
This type of trading is becoming more popular with traders in different financial markets for various reasons including: –
- Flexibility as you are able to trade on markets that are falling in addition to those who are rising.
- Hedging tools to help protect you from a possible loss in value of other investments. This can be done by you going short meaning that you make your purchases at falling market prices.
- Leverage as you can spend a small amount to gain access and control of a much larger value position.
- Stamp duty is eliminated with CFDs unlike when you are trading with shares. Purchasing a share means that you need to pay the government 0.5% of the value of the trade as stamp duty whereas with CFDs there is no stamp duty.
In addition to these reasons for choosing the CFDs, there are also some reasons that others are opting not to choose them. This comes down to the leverage, as it makes it possible for you to take up a larger deposit, which can then lead to a big loss. For that reasons, risk management with this type of trading is essential.
There are some rules that differentiate CFD trading from other types of trading. These include that a distinct lack of restrictions on both the entry or exit price of a CFD. In addition, there is no time limit for when the exchange is meant to take place. Then, you can choose the way that you want to trade, whether you are interested in selling or buying first. With other trading methods, you normally will buy the stocks first, and then choose a time when you will be selling them.
Before you choose CFD trading, you need to decide whether it is the right thing for the investor and it if will give the benefit expected This means that one needs to be averse to risk as it is possible to make a massive loss if things do not go as they are expected. For this reason, before going into full CFD trading, then one needs to try out a demo account to see how strategic they are in making money and decisions. This type of trading is best suited to people who are looking to make a return in the short term as they can be held open for a few days or for as long as the trader wants. Furthermore, you can cut out the middleman and this makes all the decisions on what you want to invest in. There is no need for anyone to trade on your behalf. Finally, you can have a more diverse portfolio.