CFDs are gaining more and more popularity worldwide as one of the most cost-effective ways to enter the global financial market. Online CFD trading has a reputation as a moderate-income generation method with a low entry cost. You can start trading without owning any assets! Below is a detailed guide that will help you understand CFDs better and decide whether you want to try them or not.
What Is a CFD?
CFD (Contract for Difference) is a contract between a seller and a buyer with the purpose to make a profit on the difference between the opening and closing price of a particular instrument.
The main rule is very simple to remember. If the closing position is above the opening position, the buyer gets the difference, while the seller loses it. If the closing price falls beyond the buying margin, the buyer pays the difference to the seller.
As a trader, you can speculate on the prices of various financial instruments by accepting your responsibility to pay the difference if you close the contract on the negative point. In any case, the seller retains ownership of the assets, which might be equities, cash, derivatives, securities, and contractual rights to receive or deliver equities and cash.
How the Trading Process Goes
CFD trading is powered by a network of brokers who are responsible for supply and demand management and healthy price formation. Still, CFDs are not traded through average exchanges where you usually trade forex and other popular instruments. Brokers use separate platforms, on which you can create an account only for CFDs or for CFDs and forex. The trading process includes the following steps:
- If you (or any trader) expect the price of an asset to go up, you can open a buy position (“go long”);
- If you expect the opposite, you can “go short” and open a sell position;
- If you purchase a CFD expecting it to rise, you can benefit if the price rises or lose money if it drops;
- If you buy a CFD with a fall expectation, you earn if it really drops and lose if it grows.
Trading on a Margin
This term means a deal when you borrow credits from your broker to purchase an asset. This way, you can own futures, shares, commodities, indices, and forex without investing your own money.
But is it safe? Of course, betting on price negative and positive movements with someone else’s money involves risks. If your prediction appears to be right, you will be able to return the money. If not, you will have to pay the debt with the original asset, or cash. You can short a CFD in advance to minimize your losses.
What Is Leverage?
A CFD leverage lets you multiply your earnings (or losses) on relatively small price movements and gain greater portfolio exposure. It works like this:
- The broker transfers a deposit to your trading account;
- You gain access to more underlying assets;
- As a result, you need to invest only a percentage of your capital, while the rest is provided by the broker.
Main Underlying Assets in CFDs
CFDs let you use a wide range of underlying assets, but the most commonly used of them are:
- Forex – foreign currency exchange;
- Cryptocurrencies – virtual money;
- Interest rates – let you make money on the movement between fixed and floating rates;
- Bonds – government debt instruments;
- Stocks – fractional ownership of a corporation;
- Commodities – raw and primary products;
- Indices – hypothetical securities that represent markets and market segments.
Follow the News
As CFDs are considered a speculative form of trading, risk management must be your top priority. Always follow the news and avoid making purchases and sales that are not transparent enough for you. Investous.com will help you with self-education, but the choice to start is only up to you.