What is CFD trading?
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CFD is an abbreviation for contract for difference.

Contracts for difference (CFDs) allow you to speculate over the counter (OTC) markets on underlying financial assets (instruments) such as stocks, indices, commodities, currencies, and treasuries.

A CFD is a financial derivative whose value is based on the underlying financial asset, allowing the trader to profit from price movements rather than owning the underlying asset.

Rather than buying a specific asset, the trader can speculate on how the price of that asset might change.

By agreeing with a CFD broker, you agree to exchange the difference in the price of an underlying asset from the opening of the trade to its closing.

In other words, after opening trade at a specific price, you wait for the price to rise or fall and eventually make a profit or suffer a loss from the difference in the asset's value when it is closed. Contract.

How much profit or loss you make depends on how correct your forecast is.

How does CFD trading work? 

Simply put, trading CFDs allows the trader to make a profit if a market moves up or down.

CFD trading is a flexible alternative to traditional trading, giving the trader the flexibility to trade the price of an asset rather than buying the asset itself. To start your way in CFD trading professional brokers recommend using dotbig.com.

By not owning the underlying asset, you can benefit from the underlying markets that are going up in price, as well as those that are going down. In other words, as a CFD trader, you can trade when the markets go up or down, 24 hours a day.

With CFDs, traders can trade from a trading account with the prices of different underlying assets, such as stocks, currencies, indices, and commodities such as oil or gold.

Each CFD has a  buy price (ask price) and a selling price (bid price) based on the underlying asset's price.

If you expect that the price of the underlying asset will rise, you buy. This is called  "going long"  (also known as a "long trade" or "long position"), which means buying a CFD to sell at a later stage.

For example: Let's say the current market price of gold is $ 1,600 an ounce, and you anticipate that it may increase. You open the trade (buy) at the current price of $ 1,600 an ounce and close the trade (sell) when the price of gold reaches $ 1,620 an ounce. Your profit will be $20.

“Going short” (also called “short position” or “short trade”) involves selling a CFD  to repurchase it at a later stage if you think the price of the underlying asset will go down.

For example, you open a short trade (sell) when the current market price of gold is $1,600 an ounce and close the trade (buy) at $1,540 an ounce, making a profit of $60.

CFDs follow the price of the underlying market. The more the market moves in the direction you predict, the higher your profits will be. The more you move in the opposite direction, the greater your losses.

CFD trading also involves concepts like leverage, margin, hedging, and spread. 

CFD leverage 

CFD trading is leveraged, which means you gain access to more of the market without having to compromise the total cost required to open a trade.

For example: if you have $2,000 available in your CFD trading account and your CDF broker allows you 50: 1 leverage, you can access $ 50 for every $ 1 in your trading account. In other words, you are allowed to trade up to $ 100,000.

The implication is that with a relatively small deposit, you can still make the same returns as you would with traditional investing, with the difference that the return on your initial investment is much higher.

However, the risk is that potential losses are magnified to the same extent as potential gains.

Please note that your profit or loss will be calculated on the full size of your position, which means that the difference in the price of the underlying asset will be calculated from the point where you opened the trade to the point where you closed it.

The consequence is that both profits and losses can increase significantly compared to your initial investment and that losses can exceed deposits. Therefore, your leverage ratio is critical, and be careful to trade within your available funds.

Margin 

There are two types of margin in CFD trading:

A deposit margin

It is the amount necessary to open a trading position.

A maintenance margin

It is the margin that may be required if there is a chance that your deposit margin and any additional funds in your trading account will not cover potential losses. If this happens, your CFD broker may call you and ask you to top up your trading account. With insufficient funds in your trading account, your trading position may be closed, and losses incurred will be posted. 

Coverage 

CFDs can also be used to cover losses on another existing portfolio.

For example, you have several shares of the company XYZ Limited in your current portfolio, but you expect these shares to decline in value in the future. By using a short position through a CFD trade, you could offset some of the potential loss. Any drop in the value of XYZ Limited shares would be offset by a profit on your short CFD trade. 

Spread 

In CFD trading, the spread refers to the difference between the buy price and the selling price.

The purchase price will always be higher than the current market price, and the sale price will be lower. The underlying market price will generally be in the middle of these two prices.

The cost of opening a CFD position is covered most of the time in the spread. This implies that the purchase and sale prices will be adjusted to reflect the operation cost. 

Calculation of profit or loss from CFD trades 

Multiply the total number of contracts by the value of each contract and then multiply the first answer by the difference in points between the closing price and the opening price of the contract. 

A) Yes, 

Profit or loss

=

(Number of contracts x value of each contract)

x (closing price - opening price)

For a complete picture, distribution costs should be considered and other applicable fees or charges. 

Advantages of trading CFDs 

CFD:

Disadvantages of CFD trading

CFD traders must pay the spread on the opening and closing positions. The result is that it is potentially more difficult to generate small profits.

Trading CFDs can be risky and should not be traded without a thorough risk management strategy. 

CFD brokers and platforms 

It is important to choose the right broker who can offer you a   reliable online CFD trading platform to start CFD trading.

It would help if you are looking for a regulated, licensed, safe, and experienced broker who you can trust.

Author(s): Alex Nilson
Published at: 10 Aug 2021 12:31 GMT
Original link (login required): https://ilde.upf.edu/pg/lds/view/236303/