What is CFD (Contract for Difference)
If Forex trading is not an investment option for you, then other alternatives should be considered.
One of them is CFD trading, which means Contracts for Difference.
What are CFDs? CFD is an agreement to exchange the difference in the value of a specific asset from the moment the contract was opened until the moment it was closed.
Let's take a closer look: What are CFDs and how to trade them?
An interesting fact about CFDs is that you never actually own a certain instrument or the asset you have chosen to trade, but you still benefit from the market moves in your direction.
From a technical point of view, this is because a CFD is a so-called derivative commodity, the value of which depends on the underlying asset.
If you want to trade CFDs, there are many brokers who can help you. They have different platforms that are designed specifically for CFD trading.
In this article, we will explain what a contract for difference is and under what conditions this type of trading is performed.
What are CFDs and how they work
By trading CFDs, you have the opportunity to receive profit from any market movements. If you are firmly convinced that the price of an asset will rise, you enter a buy position, often referred to as a long position.
If you think that the price of an asset will fall, you open a sell position, which is called a short position.
The actual situation in the market not only influences whether you receive an income or a loss but also determines its size.
For example, if you believe that a particular market will go up, you buy CFDs to trade them.
Here is the answer to the question of what is CFD and how it differs from Forex.
The longer the market rises, the higher your profit will be, and conversely, the longer the market declines, the greater your losses will be. The opposite rule applies if you are betting that the market will fall – the longer the market falls, the more profit you will get, and if the market rises, you will suffer a loss.
It's no secret that with different brokers you can trade CFDs on a huge number of markets, including indices, stocks, Forex, commodities, cryptocurrencies and etc.
Let's find out further – CFD trading is what it is and how it is applied in practice …
CFD trading what is it
What are stock CFDs?
For example, CFDs on stocks are trading that is very similar to traditional stock trading, but it has additional advantages – cost and convenience.
You can also trade markets such as the stock market indices using CFDs. This option is not available for direct trading. However, you should be aware that CFDs are leveraged and can result in losses that exceed your initial deposit in your CFD trading account.
Let's take a look at the buy and sell price. Let's take an example of these prices in each market from the position in which you see them in the main market.
First, consider the bid price (which comes first) and the offer price (which comes second). The difference between these two prices is called the spread.
If you predict the market will rise, you buy at the bid price (or even higher), and if you think the market will fall soon, you sell at the bid price (or even lower).
How do I calculate the profit and loss on my CFD account? It's actually very simple. amount shares(or contracts, in our case) which you choose is entirely up to you.
You only have to comply with the minimum size allowed for each specific market. You should remember that the value of one contract in different markets can vary.
For example, one contract on the FTSE 100 costs £ 10 for each point that the underlying index moves. Thus, if you go long on one contract, the FTSE 100 and the index will rise by one point.
This will mean that you will make a profit of £ 10. Likewise, one can assume that one full EUR / USD contract is worth $ 10 for every pip of movement in that currency pair.
If you are going to short one contract on the EUR / USD pair, and the price rises by one point, this will result in a $ 10 loss for you.
What are a CFD contract and its expiration
Most CFD traders do not expire. If you wish to close a position, you simply place a position with the same value but in the opposite direction.
We will give an example to explain what CFDs are in simple terms.
Imagine you bought 100 BP shares as a CFD. The price starts to fall, so you are more likely to close the position before you lose too much money. To do this, you need to sell 100 BP shares as CFDs.
Of course, this does not always happen, exceptions are possible.
Some brokers may offer forward contracts for different commodities, but which will expire at a certain time in the future.
It is important to know this in order to better understand what CFD contracts are in the financial markets.
But, in any case, you do not have to wait until the expiration date to close your forward contract – instead, you can trade at any given time.
For forward contracts, no additional deposit is required as the price is already included in the spread.
What are CFD trading and its benefits
In CFD trading, many brokers have a huge range of options to offer you, perhaps more than any other type of trading. Let's focus on the main benefits that can be obtained with a CFD account.
The first advantage that comes to mind is Direct Market Access (DMA). Several providers offer DMA, allowing you to trade directly from the underlying orders on capital exchanges around the world.
With so many brokers, you will have access to a huge range of markets, in particular the stock markets, options, Forex CFDs, Commodities, and Interest Rates.
By understanding that you never own the main market, you can trade in other markets that would otherwise be impossible to trade. The markets we have mentioned are the most popular and most suitable for CFD trading. Nevertheless, their complete list is simply huge.
It covers a growing number of ETFs and ETCs, not to mention the impact of economic and political news releases.
The list of benefits is not yet complete. Trading CFDs makes it easy to take advantage of falling as well as rising markets, unlike most traditional forms of trading.
Remember that you can generally have low commission rates on the contract value on some CFD shares.
If you prefer short-term trading, then we have good news for you. CFD trading is completely suitable for short-term trading…
Since you can trade CFDs on margin, you can capitalize on short-term market volatility without the need for a large initial investment.
CFD trading can be limitless. This means that you can access trading opportunities around the clock with the help of different brokers.
This is called 24/7 trading, which means that you can even open and close positions when the main market is closed. Moreover, CFD trading does not have a fixed time frame.
CFD shares do not have a specific expiration date, although in some markets each trade has a specific expiration date. In turn, this assumes that you can close your positions on CFD shares anytime you want.
CFD trading can be done extremely quickly, but this speed depends on the broker you use.
Some brokers offer trading platforms where you can open and close positions in the blink of an eye.
To find an explanation for CFD trading, you should know that real prices are quoted on a good trading platform and that different automated systems can execute all of your transactions instantly.
It is important to note that in CFD trading you can use leverage… This means that in order to open each trade, you need to set a fraction of the position value.
This will allow you to free up some of your capital for other important purposes.
You should also remember that even though there is an actual buy when trading CFDs, you still remain in the markets you are currently trading.
CFD trading is not only advantages but also risks
We have understood the concept of a contract for difference or CFD. What is the risk of trading them?
The main risk associated with CFDs is a market risk…
If the market moves against you, the value of your position will decline. It is no different from other risks that are present in other traditional forms of trading.
What is CFD trading?
CFDs are a leveraged commodity, so they can significantly increase the risk of large losses.
What do CFD contracts mean and news strategy
CFD traders need to be aware of new movements in the financial markets. Many market participants use news headlines to define common persuasion as a strategy for opening new positions.
News streams can seriously affect asset prices and generate new opportunities for CFD trading, so it is important that CFD traders are in control of all future news releases and information events. Sentiments can change overnight, so traders should be prepared for this.
News trading is often based on press releases from different countries, which increases price volatility in the short term.
Let's take a look at some CFD strategy tips that you might find useful.
Most of the time, these releases deal with decisions on interest rates, additional jobs, inflation values, national trade balance, and industrial production.
In turn, these press releases are planned in advance, and the reports are instantly available to all market participants.
For this reason, press releases allow CFD traders to profit from predictable price volatility.
There is no need for special “inside information” to understand the overall trading environment.
One of the most significant market fluctuations that come out at the end of each month is the American indicatorNFP… This indicator, according to most analysts, is one of the best-known indicators of the health of the American economy.
In addition, this release tends to be followed by large price fluctuations. Whether the number is negative or positive affects post-release price activity, which can create the potential for new entry points for CFD trades.
Since some markets tend to influence other markets in other regions, the news headlines that appear during the session can show you the direction of movement of later prices for assets that are traded on other continents.
Consider this by applying trading strategy CFD.
Another reason to watch news releases closely is that these releases can have both positive and negative effects on the CFD positions already open.
Therefore, it is not entirely wise to open large positions before serious news events. Opening positions before this kind of release are risky, as the success or failure of the deal will depend on the news release.
Therefore, with this in mind, it is still safer to wait until the risk from the event has passed before opening new CFD positions.
The timing of news releases that strongly influence market movements are generally easy to predict – for example, earnings reports are published every quarter and dividend announcements are planned ahead of time.
However, other types of news that affect CFD positions, such as changes in management or mergers and acquisitions, can suddenly hit the market.
This is one of the features of the CFD strategy.
These situations can negatively impact open positions, but CFD traders can lessen the negative impact by carefully monitoring the news feeds and making decisions based on the major events of the day.
Traders who choose to focus on this information will have a significant advantage over those who did not, because losing positions can be closed with limited losses, while successful trades can be left open to keep profits growing.
If CFD traders do not actively follow the news, they will not be able to obtain information that determines price action at any given moment.
A CFD hedging strategy is …
When there is a significant increase in market volatility, many traders start looking for methods to protect their assets from unpredictable or extreme price movements.
Probably one of the most popular strategies used for this purpose is hedging.
This is the first CFD trading strategy for beginners. It is used to balance assets and prevent future losses.
Hedging can be implemented either by opening opposite positions in the respective markets or by directly buying and selling the same financial instrument, neutralizing the risk from volatile trading conditions.
This CFD strategy is usually used when prices fluctuate at a higher level than normal, or when investing in assets with wide trading ranges.
Hedging can also be used when the CFD has reached the target profit level and you want to take profit without closing the position.
Hedging is a minimum risk trading strategy as it seeks to eliminate risk entirely.
What is CFDs on shares
Let's assume we have a successful CFD open position on stocksGoogle… Prices are up 2% of the entry purchase price and we believe the current uptrend may reverse.
In such a situation, we want to protect our profits, so we have two options. We can either close the trade completely or open a sell position in the opposite direction to balance our overall result.
Therefore, this way we will have two open positions of the same volume.
If the price continues to rise, then the buy position, in fact, will suffer losses, but our total profit will not change if a hedged position is opened.
This is an important characteristic to keep in mind if you are interested in this CFD trading strategy.
In addition, if the price reverses and a downtrend begins, the sell position will be profitable, while the original buy position will lose some of its original profit.
But the total profit will remain the same. As you can see, hedging allows you to completely reduce the risk of your CFD trading, as it is impossible to take a loss if you have a second opposite position.
By using hedging strategies, CFD traders can minimize the impact of events and protect their open positions.
Another significant factor is that risk reduction also means that you will not be able to make a profit, so hedging should not be seen as a viable CFD strategy under any trading conditions.
CFD Trading – Summing Up
CFD is an interesting investment tool.
Trading CFDs can make good money. As with all types of trading, you should have a good understanding of the markets and all their aspects in order to maximize your chances of making a profit.