CFDs are leveraged financial products that are traded over the counter.
CFD brokers and traders form this contract between them.
This contract stipulates that after the trading position is closed, you exchange the difference between the opening and closing price of the asset being traded.
The types of assets traded in CFDs include shares, stocks, cryptos, indices, currencies, and commodities.
One important aspect of CFDs is the lack of ownership.
Traders don’t own the underlying asset and instead, they bet on its price movements.
Therefore any benefits or responsibilities related to asset ownership do not apply to CFDs.
Another important element of trading CFDs is a marginalized deposit.
Here, you don’t have to pay the full cost of the transaction to start your trade.
You pay a small percentage of the total cost which is known as margin.
The ability to trade on margins makes CFDs leveraged products.
Leverage is what makes trading CFDs both profitable and risky at the same time.
Opening positions using small deposits to make substantial gains is what makes CFD trading exciting and intimidating for beginners.
Let’s understand how a CFD trade works.
CFD trading takes place through a trading platform provided by brokers.
A trader goes through the CFD portfolio and chooses on which asset he wants to trade.
He then selects the number of units (contracts) of that asset.
He may add any risk mitigation features such as stop-loss or take-profits.
Finally, he chooses to go long or short, i.e. he decides to open a buy or sell position.
For example, you choose to deal with broker AAA for CFD trading.
You choose to go long on CFD shares from XYZ Corporation as you anticipate its price will increase.
Each contract is worth $15 and you decide to buy 50 contracts making your total transaction value at $750 ($15 x 50).
The margin is set at 4% which means you only pay $30 (0.04 x $750) to open your position.
You close your position when the price increases to $18 making your total profit stand at $150 ($3 x 50).
Say, if the price had dropped by $3 instead, you would’ve faced a loss of $150.
Thus by investing a small amount, you are able to deal in positions of high value.
Let’s take a look at some of the advantages and disadvantages of CFDs as it is crucial to know them before stepping into trading.