Contracts for Difference (CFD) is a derivative that allows its traders to speculate on the rise and fall of the prices of assets such as indices, commodities, currencies, stocks, and more. The only difference it has against other markets is that traders don’t own the underlying asset and only pay a minimum deposit to open a trading account.
How Does Contract For Difference Work?
CFDs are well-known derivatives that share a contract between a buyer and a seller. The one who will pay the difference of the entry and exit price will be the losing party. The trader controls the volume of the trade that they want and the only thing they can’t control is the price of the underlying asset. The price of the underlying asset depends on the underlying financial market of the CFD.
Long and Short Trading Positions
CFD traders speculate and also trade on different instruments of various classes. When the trader thinks that the price of the asset will rise, then he can buy a Contract for Difference. This will allow him to profit in the market out of the difference in the buying and selling price. The same way that the trader can profit even in the falling prices of the market when he chooses to short-sell a CFD.
Traders Don’t Own the Underlying Assets
One major characteristic of CFD trading is that the trader does not own the underlying asset that he is speculating. For instance, you bought CFD on Brent crude. In this case, you don’t own the oil physically. Instead, you are given the chance to speculate on the price of Brent crude just by paying a minimum deposit. When the price goes up, you will make a good amount of profit. But if the price dips down, the trader will incur losses.
Leverage in CFD Trading
Another reason behind the popularity of CFD trading is leverage. It is like a loan you acquire directly from your broker. From that money, you get to open larger trading positions without paying a huge amount of money. Some brokers offer too much leverage that regulators from several countries made a cap to control the losses that can be incurred as the leverage goes up.
There are regulatory agencies from different countries all over the world. They aim to protect the trader from higher risk as they take on higher leverage. What’s so scary about leverage is the fact that it is a double-edged sword. As the leverage goes higher, the risk goes higher too. It magnifies losses as it magnifies gains. Therefore, if you want to benefit from CFDs, you must ensure that you have knowledge before using them and incorporate the open positions with stop loss and risk management strategy.
Range of Markets
Unlike trading traditional stocks where you can only speculate on stocks, CFD trading allows speculation of different financial instruments like bonds, commodities, Forex, and even precious metals. CFD also has the highest leverage ratio which allows you to open more positions after paying a minimum deposit.