CFD is a term that stands for contract for difference. CFD trading lets you take a position based on an instrument’s value and predicting if it will fall or rise. CFD is a derivatives product, which means that you do not actually own the underlying asset directly. All you are doing is trading the movement of underlying prices.
The contract itself is simply an agreement between 2 parties to exchange the difference between the opening and closing prices of an instrument, hence the term ‘contract for difference.’
CFD Trading In A Nutshell
CFD trading, unlike conventional forms of trading, helps you profit from rising markets as well as falling ones. In case you believe that the price of a particular asset will rise, you ‘buy’ or go long and will profit with every increment. On the other hand, if you think that the price of a particular asset will fall, you ‘sell’ or go short and you will profit from every drop in price. Similarly, you will suffer a loss if the market does not move in the direction you expect it to.
Example
Assume that you believe that Facebook’s share price will rise in value. All you have to do is go long on Facebook’s share CFD and your profits will increase in line with the rise in price above your opening level. However, should Facebook’s price actually drop, you would suffer a loss for every drop in price. The amount of profit or loss you make for every price movement depends on your position size as well as the price market movement.
Leverage and CFDs
CFDs are a highly leveraged product. This means that you enjoy a larger market exposure by making a comparatively low initial deposit. In the end, your return on investment will be significantly higher than with other forms of investment. In conventional dealing, you have to pay the broker the full value of the asset you wish to buy but with CFDs, all you need to do is provide a fraction of the amount for the same trade.
The key thing to note about leverage is that while it has the potential to magnify your profits, it will also magnify your losses in a similar fashion. This means that if the price were to move against you, your losses could potentially exceed your initial deposit. Therefore, it is important to learn how to manage risk when trading CFDs.
What Markets Can You Trade CFDs On?
You can trade CFDs on most of the assets that have the ability to utilize leverage and you can choose to go either short or long. The most popular markets however include:
- Shares
- Forex
- Commodities
- Indices
- ETFs
Conclusion
CFDs are truly a revolutionary trading instrument. If you did not know much about CFD trading, this article is an excellent resource for learning more about this new and exciting form of trading. As with all types of investment, CFD trading is risky and you can lose more than your initial investment. Therefore, invest wisely and only use money that you can afford to lose.
