What is CFD Trading and How Does it Work?

 

The expansion of CFD is contracted for the difference. In CFD, a position on the price of an instrument is taken, but you don’t have to own that asset. You can make a profit from the falling markets and rising ones, this is the unique aspect of CFDs. You can look at CFD trading wiki, to know more about what is a contract for difference.

In the contract for difference, they do what the name suggests, there will be a contract in between two parties on the price of an asset.

Many key features of CFDs makes a unique and exciting product.

  • Derivatives products are CFDs
  • CFDs are leveraged
  • You can make a loss as well as profit from the rising and falling of prices
  • On over 1500 global markets, Olymp Trade offers contracts. The markets include currencies, indices, ETFs, commodities, and

CFDs are Known as Derivatives Product

You don’t own an asset, you are only speculating if the price of the asset will rise or fall.

For example, in stock investing, suppose you purchased 10,000 shares of Amazon, and the price of the share is 280p, it means that the total investment you would have to make is £28,000 and it doesn’t include commissions or other fees of your broker that they would take when making the transaction. When you purchased the shares, you are going to acquire stock certificate and legal documents that would certify that you are the owner of the shares. So, here you have something physical that you can hold in your hands until the time you decide that you need to sell them, and of course making some profit.

But when you are doing CFDs, you do not own the shares of Amazon. You are speculating and making a profit from the same movements that are taking place in the share price.

How are CFDs Leveraged?

CFDs are leveraged because, with a very small initial deposit, you will gain a much larger exposure in the market. Therefore, you have a significantly larger return on your investment compared to the trading of other forms.

Let us take the example of Amazon once more. You bought 10,000 shares from Amazon at 280p each, and so the total cost is £28,000 that doesn’t contain commissions as well as no additional fees.

However, in CFD trading, from the total trade value, you will be only needing a small percent to open your position and still you are going to maintain exposure of the same level. So, for example, Olymp Trade gives you leverage of 20%, which equals to 5:1, on the shares of Amazon. So, all you need to do is to make an initial £5,600 deposit and start the trade at the same amount.

When there is any rise in Amazon’s share, maybe 10%, which makes it 308p, the total value will rise to £30,800. Therefore, with only £5,600, you are going to make a profit of £2,800. It’s a 50% return on your investment.; whereas, if the shares were bought, you would have only had a 10% return.

But you have to also know that while it is magnifying your profit if you face loss, it will also magnify your losses too. Therefore, if the prices move away from you, you might be closed out of your position, or you can fill your funds again to stay open. Therefore, you should be witty in managing your risk.

Again, let’s go to the same example. Suppose the share of Amazon fell by 10% making it 252p each share. The total value of position will be now £25,200. You made a deposit of 5,600 in the CFD, and this trade has been on a loss for £2,800. So, you are facing a loss of £2,800 when you made the deposit of £5,600. That’s a 50% of the loss on the investment you made; whereas, you would have just faced a 10% loss if you had bought the shares physically.

Pros and Cons of CFD

 

Advantages:

 

  • Leverage is Higher: You are going to get higher leverage while you are trading CFD compared to the traditional trading. The average leverage in CFD market starts with as low as 2% margin, and it can go up to 20%, and it will go on rising substantially as per the new rules are set to get into effect at the end of this year. As there is a lower margin, it means you have to outlay less capital and bigger returns. But again, with a magnification of profit, your loss will also have a magnifying effect if the price lowers.

 

  • From One Platform You Can Have Access to Global Market

All major markets of the world will be part of many CFD brokers offer.

  • No Borrowing Stock or Shorting Rules

There are rules in a certain market to prohibit shorting, the traders are required to borrow the instrument before attempting to sell short or have margin requirements different for long and short posting. One can short at any time about CFD instruments, and they don’t have to borrow cost because the underlying asset is not owned by the trader.

  • No Fees for Professional Execution

Same as traditional brokers, CFD brokers have similar offers, such as limits, stops and contingent orders as “If Done” or “One Cancels the Other.” Few brokers will guarantee stops and will charge a fee for that service or will recoup costs some other way.

  • No Need for Trading at the Day

Certain markets require minimum amounts of capitals for day trading, or there will be limits on the trades that take place at the day, with certain accounts that can be made. There are no restrictions in the CFD market, and account holders can trade at the day if they wish.

Varieties of Opportunities for Trading

You will get stock, treasury, currency, commodity, sector, and index for CFD brokers. Therefore, if you are a speculator in a variety of financial vehicles, you can also trade CFDs and trade alternative to the exchange.