What is CFD Trading?

CFD Trading, which stands for Contract For Difference, gives you the opportunity to trade across a wide range of financial assets.

Best of all because you never own the actual asset with CFDs, it’s possible to make money even if that asset’s value is going down.

So are you ready to begin trading CFDs? Keep on reading to learn all you need to know about CFD trading and how it works.

 

What is a Contract for Difference?

CFDs are classed product wise as financial derivatives. A derivative is a type of financial instrument which takes its value from the value of another underlying asset. Some popular examples of derivative instruments include Options, Stocks, Commodities and Indices.

Because a CFD (contract for difference) is a derivative, they allow you to speculate on the price of an asset without the need to actually own the asset. This is the great thing about CFDs, the fact that you don’t take ownership of an asset, means that you’re free to trade how you wish.

For instance, it is possible to speculate not only on an asset’s price going up, but also on the asset’s price going down. If your speculation is correct and the price moves how you predicted, you will make a return on your position.

Whereas if you only own an asset, and that asset’s price decreases, then you have only lost money.

This flexibility has led to CFD trading become very popular with many people worldwide. Each day millions of people trade CFDs across a range of markets which includes Indices, Cryptocurrencies, Commodities, Stocks and Forex.

 

Exactly what is CFD Trading?

CFD trading is simply the selling and buying of CFDs (Contracts For Difference) from a wide variety of financial instruments, for instance Crypto and Forex. This is normally completed via an online trading platform or broker. When opening a CFD trade, you move into an agreement with the broker to exchange the price difference of a financial asset from the time you open it till the time the contract is closed.

You are essentially trading on the price movement of that asset, you just need to analyse and decide whether that asset’s price value is going to go up or down. If your forecast is correct, and that asset’s price moved how you predicted, then you make a profit. Your profit and loss is based on the accuracy level of your forecasts.

 

How Does CFD Trading Work?

So now you know that CDF trading works by opening a position based on an asset’s price movement. For instance will the value increase or decrease.

To get started you need to decide which financial market you want to trade in. For example this could be cryptocurrency, forex, options or stocks.

However, before you open that position there are some key CFD concepts that you need to consider first. These concepts include: leverage, margin, going long & short and stop-loss.

Let’s take a look at what these term’s mean:

Leverage:

Leverage is a tool that allows you to increase the spread of your position without having to pay the full cost upfront. It is a tool commonly used in CFD trading because it can magnify your return profit. Leverage can also magnify your losses too, which is why it’s a tool that we recommend for experienced traders who are aware of the risks.

Many traders use leverage in CFD trading, because they only have to put up a percentage of the borrowing costs, rather than the full amount. However, you must check the broker’s leverage ratio so you can fully understand whether you’re borrowing within your means.

 

 What does’Trading on Margin’ mean with CFDs?

‘Trading on margin’ is a term that is linked to the use of leverage. The margin is the amount of funds needed to open and sustain a leveraged position.

However, you need to remember that there a 2 margin types in CFD trading. The first is a deposit margin, which is needed to open a CFD position. Where the second type of margin is known as a maintenance margin, this is needed if your position is near to making losses that your account funds or the deposit margin can’t cover.

In this situation, your broker will normally notify you and ask you to add funds to top up your account. If this is not done it’s likely that the position will be closed and you’ll have to cover any losses that have been incurred.

 

 Long & Short in CFD Trading

‘Long’ and ‘short’ are names that note the position you decide to set up on a trade. For instance, if you believe that a financial asset’s price will go down, then you trade to sell ‘short’. If you think that the price will go up then you set your order to buy ‘long’.

This is the beauty of CFD trading, because unlike traditional trading which only offer profits if an asset or market increases in value, you can also make a profit from a market decrease. What’s important is that your forecast is correct and your CFD position moves the way you predicted.

For example, let’s imagine that you want to open a trade on a Microsoft Stock CFD. You’ve analysed the Microsoft price performance and believe that the value will continue to decrease.

So you will open a sell or ‘short’ position. The Microsoft stock price continues to drop as you correctly predicted, so you when you close your position you will have earned a profit.

 

 What is a ‘Trading on Margin’ with CFDs?

‘Trading on margin’ is a term that is linked to the use of leverage. The margin is the amount of funds needed to open and sustain a leveraged position.

However, you need to remember that there a 2 margin types in CFD trading. The first is a deposit margin, which is needed to open a CFD position. Where the second type of margin is known as a maintenance margin, this is needed if your position is near to making losses that your account funds or the deposit margin can’t cover.

In this situation, your broker will normally notify you and ask you to add funds to top up your account. If this is not done it’s likely that the position will be closed and you’ll have to cover any losses that have been incurred.

 

 What is a Stop-Loss in CFD Trading?

Many traders will use a stop-loss order as part of their CFD trading, as it’s essentially an insurance policy which helps to limit risk and financial losses.

The best way to think of a stop-loss is that it’s a pending order, which is only active when your selected asset’s value reaches a certain price level. For instance, a stop-loss order once activated, will automatically close a position. It can be used on both short and long positions and can prevent you from losing your collected trading profits should an open trade go against you.

Stop-loss orders can act as a type of free insurance policy, which helps you to minimize downside risk from trading strategies. Stop-loss orders are free to use with brokers, and they’re a good risk management tool to use.

Do CFDs Expire?

No, for most markets there are no expiry dates. This means that you can keep your CFD positions open for as long as you want to maintain them.

Even though there are no expiry dates for most CFD markets, most traders will only keep their CFD positions open for a short period of time. This is because most brokers will add fees to positions that are kept open overnight, which can slowly add up if that position is kept open for a long time. This is why day-trading is very popular as it avoids keeping overnight positions open.

However, overnight charges do not apply for Options, Forwards and Futures.

 

 Is CFD Trading Safe?

Millions of people trade CFD’s every day, so it is a respected and popular financial product. However, like all trading, there is always some element of risk. So you must decide whether you have the financial means to get involved with CFD’s, and if you do to use a risk management strategy. For instance, using a stop-loss when opening a position is one risk management tool that we’d always recommend.

It’s also very important to only use a trusted and regulated broker. Regulated brokers are officially registered and monitored by financial regulatory authorities. This means that they have to follow strict rules that keeps their trading platform’s secure and protects their client’s accounts from scams.

 

Here you can learn more on how to trade forex: https://tradingonlineguide.com/what-is-forex-trading/how-to-trade-forex/