CFD (Contract For Difference) is an agreement between two parties, usually referred to as “buyer” and “seller”, to pay each other the difference between the price of opening a position and the price of closing a position for a trading instrument.
It is a universal trading instrument offering a simple method of trading in different markets without physically owning the instruments.
By their nature, CFDs are financial derivatives that provide traders with the opportunity to profit from the movement in the value of various assets, allowing them to go long when asset prices move up and short when prices move down. Tied to the underlying asset, the CFD value moves in exactly the same direction as the underlying asset price and depends on the same factors. At the same time, being much more flexible and affordable, CFDs provide a number of advantages over trading the underlying asset directly.
If you still have a question “What is CFD trading?”, here is an example that will help you understand everything in practice. Let the starting price of Apple stock be $100. You enter into (buy) a CFD for 1,000 Apple shares. If the price subsequently rises to $ 105, the difference paid to the buyer by the seller is $5,000. Conversely, if the price drops to $95, the seller will receive a price difference of $5,000 from the buyer. The contract does not involve the physical ownership and purchase / sale of the underlying shares, which allows investors to avoid formalizing ownership of the assets and the associated transaction costs.
Margin trading allows you to take a larger position on the market with a small amount of invested capital. When the market moves in your desired direction, the leveraged profit increases as you have contributed only a fraction of the total contract value and the profit will be derived from the change in the total value. Of course, with margin trading, losses can also increase significantly if the market goes against the move you expected. Therefore, it is necessary to exercise due care when trading with leverage: risk management becomes a particularly important aspect.
Intraday trading is the process of buying and selling various assets within a single trading day. This means that during this day, a trader or investor can make any number of trades at their discretion. Since margin trading allows you to increase a position with a limited amount of invested funds, it is possible to trade CFDs even with small fluctuations in the price of an asset during one day.
Trade stocks, commodities, indices and currencies
CFD (Contract for Difference) is a versatile trading instrument that has gained particular popularity in recent years. With the help of CFDs, it became possible to play on the price movements of various financial instruments without the need to physically own them. CFDs allow you to trade not only stocks, but also major stock indices, currencies and commodities.
The ability to trade both when prices rise and fall
CFDs are flexible investment vehicles. If you are confident in a growing market, then get income by opening a position to buy CFDs. You can also speculate on the downside by selling CFDs. Holders of open positions to buy CFDs on shares receive a dividend adjustment equal to the declared dividend payout if at the time of opening of trading on the day of payment of the adjustment (coincides with the ex-dividend date), a long position is open on the instrument. In contrast, the dividend adjustment is withheld from the client’s account if there is an open position to sell the CFD.
Investment portfolio hedging
If you assume that the purchased shares will become cheaper, but you do not want to sell them, then you can use portfolio hedging strategies from risks by opening a position to sell CFDs on your portfolio of shares. Thus, the profit from a short CFD position will offset losses from the fall in the value of assets in the portfolio. You will incur lower costs compared to hedging when selling real assets and then buying them back cheaper.