What is CFD Trading?
A CFD, or Contract for Difference, is a contract between two parties to exchange the difference in value of a specific asset, between the time when the contract is first opened and when it is closed.
One of the most important thing to understand about CFDs is that you are never trading the underlying instrument financial asset, whether that is a commodity, share index fund, bond or stock. But you can benefit if you correctly predict the directional movement of that underlying asset. This is why a CFD is known as a derivative financial product. The value of the CFD derives from a specific underlying asset.
How CFD Trading Works
One of the reasons why CFD trading online is attractive is because you can profit – or make a loss – whether the value of an asset moves up or down. If you believe that asset is going to increase in value then you can open up a buy position. This is also known as ‘going long’ on the asset. If you think that the value of the asset is going to fall then you can open a sell position. This is known as ‘going short’ on the asset.
The more that the asset instrument moves in the direction that you predicted the greater your potential profits. If you have ‘gone long’ on an asset, your profits will increase the more that the asset rises and your losses will be greater the further that it declines. The reverse is also true. If you have ‘gone short’ on a particular financial asset and the value then drops you will make more money. The further the asset falls, the more money that you stand to make. If on the other hand the asset increases in value then you would lose money.
Trade ’em up! by eric1g, on Flickr. This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 Unported License.
Key Benefits of CFDs
Place a Trade when the Market Falls as well as Rises
One of the key advantages of trading a CFD. This allows you the flexibility to benefit from a wide variety of market conditions.
Leverage Your Trades
CFDs allow you to trade using margin. This means that you do not need to put down the fall in value of the position you are entering. For example if you are trading 1,000 shares of Apple with CFDs you would potentially only need to deposit 5% of the total position. If each shares costs $540 then you would only need to deposit 5% or $2700, to control the equivalent of $540,000 worth of Apple shares.
Hedge Other Investments
Because you can go short using CFDs they can be used to hedge other investments that you have made. For example, if you have retirement savings in a stock market index fund you may be concerned about the short-term risk of a declining market. You could hedge this risk by going short using a CFD. If the market falls then the losses in your index fund would be offset by your CFD.
Trade Global Markets
CFDs give you the opportunity to trade financial instruments from across the world. Not only can you trade shares and index funds, you can also trade commodities such as gold and oil.
As you can see there are a number of benefits of using CFDs. These financial derivatives provide the flexibility to make money in any market. Using leverage it is possible to make significant gains even with limited capital. CFDs, like any financial instruments, can result in losses. Therefore it is important that you educate yourself about CFDs before you begin trading.
