CFD or Contract For Difference is a trading strategy that enables a trader to speculate price movements in either direction. CFDs are not actual products, they are derivative products. They enable you to detect price changes in shares, stocks, indices and commodities in the financial market. They do not have to take ownership of the underlying assets. Visit MultiBank Group
Types Of CFD Trading– There are two types of CFD trading – Short CFD trading and Long CFD trading. You will learn about these two types of trading and their differences shortly in this article. Before a trader enters the financial market they must have a basic knowledge of what they are doing. However, CFD is not meant for newcomers, this is a trading strategy that only suits experienced and skilled traders. These traders have immense knowledge about market trends, which is why they can speculate on asset price movements.
Short And Long CFD Trading– As you have already learned that CFD trading enables a trader to speculate on price movements. A trader can speculate in both directions – upward and downward. You can imitate a traditional trade that profits as the asset price rises up. Similarly, you can open a CFD position that will profit as the underlying market decreases in price. This is called selling or going short whereas, buying is called going long.
How Does CFD Trading Work?
CFD or Contract For Difference is basically an agreement between an investor and a CFD broker. They agree to exchange the differences in the value of financial products between the contract opening and closing times. This is an advanced trading strategy that is only suitable for experienced traders. New traders should not try CFD trading. A CFD trader never actually owns the assets.
Instead, they earn money from the differences in the prices of the assets. For instance, a CFD trader does not actually buy gold, rather they speculate about the price change of the gold in the market. Therefore, an investor may use CFDs to detect whether the price of a commodity or asset will fall or rise. The traders bet on either upward movement or downward movement. When an asset’s price rises the net difference between the selling price and the purchase price is calculated. Then the gain or profit is settled through the investor’s brokerage account.
Leverage In CFD Trading–
A trader can enjoy leverage in CFD trading, which means they can gain exposure to a large position without committing the full cost at the outset. For example, a trader wants to open a position equivalent to 500 XYZ shares. In traditional trades, they have to pay the full cost of the shares upfront. But with CFD they might have to pay only 5% of the upfront cost.
However, the leverage may enable to spread of the trader’s capital further, but they must not forget that the calculation of profit and loss with be done on the full size of the position. Therefore, anyone who is using leverage should be careful because the profit and loss both get magnified by it. To avoid loss one must pay attention to the leverage ratio and trade within their limits.
CFD Trading Margin– Leverage trading is often known as ‘trading on margin’. Here the ‘margin’ represents only a fraction of the position’s total size. In CFD trading there are two types of margins- a deposit margin and a maintenance margin. A deposit margin is needed when a trader wants to open a position. On the other hand, if a trader’s trade gets close to incurring losses, there they require a maintenance margin.
When this happens, the service provider will call the trader asking them to top up funds in their account. If the trader cannot add sufficient funds to their account the position will be closed incurring losses.
The Costs Of CFDs–
CFD trading cost includes a commission ( only in a few cases), a financing cost ( that too in certain situations) and the spread. There are no charges for trading forex pairs and commodities. But the brokers charge a commission for trading in stocks.
Overview With An Example-
Suppose, a trader wants to buy a stock that has an asking price of $ 25. The trader buys 100 stocks of the share and the transaction is $2500 plus additional fees and commission. With a traditional broker, the trader will need at least 50% of the total transaction value which is $1250 in their margin account.
But with a CFD broker, the trader will need only $125 which means 5% of the total transaction value in their margin account.
The CFD trade shows a loss equal to the spread size during the transaction.
Advantages Of CFD Trading–
- Great Leverage– It provides higher leverage compared to other conventional trading styles. Standard leverage depends on the regulation in the CFD market. It could range from 1% to 5% depending on different market conditions. Therefore, it is a highly lucrative trading option for traders all around the world.
- International Market Access– Most CFD brokers offer products in all major financial markets. Therefore, a trader can access the markets all around the clock.
- No Day Trading Restrictions– In some financial markets traders need a certain amount of capital to day trade. In the CFD market, there are no such restrictions. Here all account holders can day trade if they want to.
- Multiple Trading Opportunities– Online brokers offer stocks, bonds, treasury, currency, sector, etc.
CFD trading requires lower margin requirements and that is a huge advantage for seasoned traders. Other than this there are a lot of advantages of CFD trading. An experienced trader can use the leverage wisely to their advantage. Know more download mt4 for android
Also, getting easy access to the global financial market is a major benefit. Because they can trade in financial markets from different countries all around the world, they can have access to the global market 24 hours a day. CFD trading has many technicalities that one should learn through thorough research on the topic. Without the proper knowledge, no one should enter the currency market.