CFD stands for contract for difference, a popular financial instrument. A contract for difference is a contract between an investor and investment intermediate to exchange the price differences of an asset. CFD trading is an essential element in every investor’s portfolio. However, some traders find it difficult to fully understand the real benefits of CFD trading.
What is CFD Trading?
CFD Trading is a financial derivative through which traders can speculate on short-term price movements in the financial markets including forex, shares, commodities, and indices without having to buy any underlying assets. Contracts for the difference is a form of derivative trading, which means they derive their value from the market performance of the asset.
The value of a CFD contract does not reflect the value of the asset, only the price change between the trade entry and exit points.
When trading CFDs, you agree to exchange the difference in the asset’s price between the opening and closing prices of the contract. Both the trader and broker are engaged in the contract according to market conditions, the trader as the “buyer” and the broker as the “seller”.
CFDs trading allows traders to trade price movements without actually owning the asset and avoid the costs and disadvantages of traditional trading.
How CFD Trading Works?
Profits and losses in CDF trading are determined by the price difference between the opening and closing prices of the contract. If you think the price of an asset will rise, you would open a long (buy) position and profit as the asset price rises as expected. But if you think the price will fall then you would open a short (sell) position and profit if it falls. Both profits and losses will be realized once the position is closed.
As you speculate on price movements, your trading will be profitable if you predict correctly. If not, you will lose. In case of profit, the broker or “seller” will pay the trader the contract difference. While in case of loss, the trader or the “buyer” will pay the broker the difference.
To easily calculate the profit or loss in trading CFDs multiply the difference between the entry and exit prices by the number of traded CFD units.
CFD trades have no fixed expiry dates so if you want to close your position, you have to place an order in the other direction. If you keep your trade open for a longer time, you will have to pay interest every time you keep your trade open overnight. That is why CFD trading isn’t really suitable for long-term positions.
Advantages of Trading CFDs
- Global Market Access: Most CFD brokers enable around-the-clock access to the world’s major markets. CFD traders can trade a variety of products in the global markets.
- Going Long and Short: CFD trading allows traders to go both long and short on traded instruments, taking advantage of every market movement.
- Higher Leverage: CFDs are leveraged, which means that you only have to deposit a small percentage of the total trade value to open a position. For example, trading with a 5% margin rate means that you only need to deposit 5% of the full trade value. Brokers usually offer high leverage levels for CFD trading. AximTrade offers competitive leverage levels up to 1:infinite. With low margin requirements, traders can magnify their potential profits to the maximum. However, it should be considered that leveraged trading magnifies losses as well as profits.
- Diversity of Trading Opportunities: Contracts for difference are offered on a variety of markets and assets including commodities, currencies and indices which diversifies trading opportunities and allows greater flexibility.
Disadvantages of Trading CFDs
- Regulations: Despite its popularity, the CFD market is not highly regulated. That means every trader should investigate the regulatory background for the broker before opening an account. Check how to choose the best broker.
- Trading Costs: In CFD trading, traders will have to pay spread on entry and exits points. This means that profits from smaller moves can be easily eliminated by spreads. This is why spread costs are a major disadvantage of trading CFDs.
- Trading Risks: CFD trading requires constant monitoring due to its fast-paced nature. Similar to other financial markets, CFD trading is subjected to liquidity risk and leverage risks.
Leveraged CFDs Explained
Leveraged trading is also referred to as margin trading or trading on the margin because the funds required to open and maintain a position, known as the margin, represent only a small fraction of the total position size.
There are two types of margins when trading CFDs. A deposit margin is required to open the position, while the maintenance margin can be required if your trade gets close to incurring losses that the deposit margin will not cover. In this case, you may get a margin call from your broker to top up the funds in your account. The position can be automatically closed and any losses will reflect directly on the trading account if you don’t add sufficient funds. Check more about Forex Leverage.
What Markets Can You Trade CFDs on?
Contracts for difference are available for multiple global markets and asset classes, all available for leveraged trading and going both long or short including:
AximTrade provides CFDs on indices, commodities, currencies, and cryptocurrencies. Enjoy access to multiple CFD assets and constantly growing trading options in one place.
CFD vs Spread Trading
Many traders may confuse between CFD trading and Spread trading as both are based on the differences in prices. When trading CFDs, the currency you trade in will depend on the specific market and currency exchanges may be involved, adding to your overall costs. While spread trading allows you to use your preferred currency, which allows you to always know where you stand.
When trading CFDs, the amount per point is decided by the provider but spread trading, on the other hand, enables you to choose the amount per point, giving you total control over how much you’re trading.
What Makes CFD Trading Successful?
Like any investment, education is the key to success. A successful trader is an educated trader. With solid market understanding and trading strategy, a trader can be prepared for success. Check our free Forex Education section for more educational resources.
Start CFD Trading
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