What does CFD trading mean?
CFD (Contract for Difference) trading is simply a form of Forex trading that gives a trader or investor the possibility to take a position on the price of any trading instrument without actually owning the financial asset.
In CFD trading, a trader can effectively decide to trade on a margin. This simply means that they can either sell an instrument if its price decreases (going short) or buy an underlying instrument if the price rises (going long) by means of speculations.
Characteristics of CFD Trading
1. CFDs are Derivative Products
CFDs provide a medium for Forex traders. With CFDs, you can make profits from price fluctuations. This is true even if you don’t own the financial instrument. There are derivatives, meaning the underlying asset can’t be owned, bought, or sold.
An investor can only buy or sell a number of units for a specific financial asset. This is dependent on speculation about whether the price will increase or decrease.
For every point the price of an instrument moves in a trader’s advantage, they gain multiples of the number of Contract for Difference units purchased or sold. However, for every point the price of a trading instrument moves against a trader, losses occur.
For example, in a stock investment, a trader or investor can easily buy 10,000 shares of MacBite for an amount of 280p.
This means that the total stock investment amounts to $28,000. That is doesn’t include commission and other transaction fees charged by the brokerage company. In exchange for shares, the Forex trader receives a stock certificate. This certificate is a legal document that states ownership of shares.
With this done, they have a physical object to hold until a decision is made to sell it and procure profits. However, in CFD trading, the trader does not own the MacBite shares. They are just speculating and hoping to make a profit from the share’s price movement.
2. CFDs are Leveraged in Nature
CFD trading provides higher leverages. This means that a CFD trader can gain a large market exposure for a reasonably small initial deposit.
CFD trading tends to make more profits for an investor, compared to other forms of trading. For CFDs, opening trade positions and maintaining market exposure are small parts of the total value.
For example, a brokerage firm gives you 5:1 leverage ratio (20 percent) on MacBite shares. You will only require an initial deposit of $5,600 to trade the same amount (using the stock investment above). What if MacBite shares increase 10% to 308p?
The value of that stock investment position would now be $30,800. Therefore, with an initial deposit of $5,6000, a CFD trader or investor has made a return on investment worth 50% ($2,800). That is the same amount that the stock trader above made.
In conclusion, being able to buy or sell a financial instrument, coupled with leveraging CFDs, is profitable. It makes it one of the most profitable ways of trading in the Forex market to follow price fluctuations.