If you are a newcomer to the world of CFDs and online trading you have come to the right place. If you are a seasoned guy in the field, this might not be for you. This article is an introduction to the term and world of CFDs.
You might have heard the term being thrown around online here and there, but never truly understood what it is about. The term itself means “Contract For Differences”, which in itself might not be that helpful. What lies under the terminology is the ability to make a contract with a broker such as ETX capital or IC markets, according to which you take on the risk of difference for the duration you own them. If the asset rises within that time, you, the trader, gets the profit and if it falls you cover the losses. It is important to understand the underlying asset is never traded, but that the CFD just make you able to speculate on the asset in question. You will never own any of the assets you are trading with, but you will be making a contract with a broker that does.
To further clear up the concept of CFD trading let us run through an example. You go select your favourite asset and the price for this asset is $10, you then initiate a CFD trade of 50 shares with this asset. This trade, if made through your normal brokerage would cost you $500, without any of the around lying fees or expected trading costs.
This is where CFD will differ significantly, a CFD broker will sometime be able to offer it at a 5% margin, which means a trade that could cost you $500 to enter, now costs you $25. Even though margins and leverages will vary depending on both the chosen CFD brokerage firm and the assets traded. Traders are often able to have a much lover entering cost.
When a CFD is opened up your initial position starts on a loss. The loss will be tied up to the spread of the traded asset. In other words, if you trade on an asset where the broker offers up a spread of 15 cents, for you not to lose anything on this trade the asset need to go up at least 15 cents.
Now we will examine the return compared to conventional stock trading relating it to the already used example. So let’s imagine that the asset traded above is a stock of some kind and that the asking price of that just went up from $10 to $20. If you were to be a conventional stock trader you would now have double your investment from $500 to $1000, a profit of $500.
This is where it gets interesting. With a CFD you are getting the difference from when you entered a trade, which is still $500, but with CFDs, your initial cost was only $25 and not $500. So when calculating your profit contra investment in percentage, you make a lot larger profit. But in the same way as your percent wise profits will be bigger, so will your losses.
This model of trading works absolutely best for you if you are a day trader with low capital. If you are in for holding onto assets for longer than a day at a time, CFDs might not be for you. This is also why the CFD trading is usually done in faster changing and more liquid markets such as Forex, Energies and Cryptocurrencies.