What is CFD Trading?
Contracts for Difference, know as CFDs, are a type of derivative trading that enables the trader to gain potential profit through speculation. They allow you to open a contract for difference in price of an asset, and are based on the falling or rising prices of global financial products or markets such as currencies, indices, shares, commodities, and treasuries.
The popularity of CFD trading is largely down to the ability it gives to trader to be able to speculate on the future movement of market prices, regardless of whether the underlying markets are rising or falling. In other words, you’re able to bet on whether you think a particular asset will rise or fall. An easy way to understand CFD trading is to look at it as a transaction. Simply put, you’re making a trade transaction with somebody on the other trade side. For example, when buying a stock you’re betting that the asset is going to rise. At the other trade end the person is betting that the asset will fall. With CFDs, you have a great deal of flexibility in trading, as they allow you to profit regardless of the direction of prices in the financial markets.
As already mentioned, you can make use of CFDs in speculating and trading in the price movements of many financial markets, irrespective of whether the prices are falling or rising. You can choose to go long/buy in a CFD market and make your profit from rising prices or go short/sell and make a profit from prices that are falling. In addition, CFD trading is a leveraged product. It allows you to maximise your market exposure for just a small percentage of the investment that you typically would need to trade directly with the underlying asset.
CFDs are not accessible to US investors. However, they are available to investors based in several other countries such as Canada, Japan, Germany, France, Singapore, the Netherlands, the UK, South Africa, and Switzerland.
Benefits of trading with CFDs
Along with allowing you to speculate irrespective of a rise or fall, trading with CFDs enables you to trade against commodity share price movements without the need to actually sell or buy the physical shares, and can boost investment capital return/risk as you will be trading on margin. What this implies is that when trading CFDs you aren’t required to put up the full shares value of what you are actually trading. Rather, it’s only a margin or deposit that covers any potential position loss that you need to put up. This makes it more assessable, as you don’t need to invest an initial large deposit.
However, it’s important to understand risks involved and that you can stand to lose more than what you initially deposited, typically a small percentage of the contract full value. Used with caution though the leverage can greatly boost your potential gains, but do keep in mind that similar to other forms of trading, a risk factor that is significant if you don’t fully understand the market or trade without caution. Ensure that you have an in depth understanding before attempting to trade live, seeking advice from an independent financial advisor if necessary. Look for reputable companies that offer free trials and a ‘learn’ function (such as CMC Markets), as well as good starting rates and minimum commission.
CFD Trading on other markets
CFDs aren’t just for equity trading. Trading platforms also offer CFDs on forex (foreign exchange), stock indices, metals, energy contracts, and other commodities. When trading Contracts for Difference on non-equity markets, you sell or buy a specific number of contracts, each of the contracts representing a given return/risk on the product underlying that market.
Those already trading Forex may also engage in trading commodity CFDs and equity index on the same platform. CFDs will not require that you own the underlying commodity or equity index, the advantage being that you bear zero risk of having to physically take possession of the concerned asset.
In general, CFDs are a good means of trading, as they allow you to invest minimal deposit to get started, and you can make a profit regardless of market direction. However, the smart trader ought to abide by one rule that overrides all the rest. The number one trading rule is to never bet more than you can afford to lose. Always start by betting small. This is particularly important with CFDs as they are a leveraged product, and as a result require a high level of risk management. Any successful investor will tell you that if your downside is protected, the upside has a far better chance of taking care of itself as well. Always ensure that you have a well rounded and in depth understanding of any means of trading before starting to minimise your chances of risk.