CFD

What is a CFD?

A contract for difference, or CFD, is an increasingly popular financial contract that’s used to speculate on the prices of various assets. In a CFD a contract is struck between the buyer of the CFD (client) and the seller of the CFD (broker). That contract stipulates the buyer pays or receives the difference between the current value of the underlying asset and the future value of the underlying asset when the CFD is sold. This allows a client to speculate on the price of an asset without the need to purchase and own that asset. Because CFDs come with several benefits, their popularity has increased dramatically over the past decade.

How do I Trade CFDs?

Trading CFDs is accomplished through a CFD broker. So, the very first step you need to accomplish is to set up an account with a CFD broker and then fund that account. Next, you should become familiar with how CFDs work and how to place orders on your broker’s trading platform, in order to start trading.

Once these basics are done, you need to decide which asset you are going to speculate on. It’s best if the asset is one you are familiar with, since this may help you to forecast the potential price movements of the asset. Decide if you believe the price of the asset will rise or fall and based on that, purchase either a long CFD or a short CFD.

Once you’ve opened your position you’ll need to monitor it. You can close it out if it goes against you in order to limit your losses, or wait until it is sufficiently profitable and can close it to collect your profits.

What are the Benefits?

CFDs have become so trending, because they offer a number of advantages. The benefits of trading CFDs are as follows:

• CFDs allow for leverage, which means traders can utilize their capital more efficiently (with risk).
• With CFDs you can access every asset class from one platform.
• There are no shorting rules when trading CFDs.
• There are no day trading rules when trading CFDs.
• CFDs come with favourable tax treatment in some jurisdictions.

Short and Long Trading

A CFD allows the trader to speculate on the price movement of an asset in either direction. If you believe the price of the asset is going to rise you can open a position to speculate on that, which is also known as a “long trade”. On the other hand, you might believe the price of an asset is going to fall. You can open a position to speculate on that scenario as well, and this is known as a “short trade”.

With a long trade your potential earnings come from rising asset prices, but with a short trade your potential earnings come from a falling asset price.

Risks of CFD Trading

While there are benefits to trading CFDs, there are also risks and it is important to understand them before venturing into this type of speculation. One of the chief risks is actually tied to one of the benefits of CFDs and that is the leverage risk. While leverage helps improve the efficiency of capital usage, it can also magnify both gains and losses. Magnified gains are good of course, but magnified losses can cause a trader to lose everything on a single badly-managed trade. This also presents the possibility of a margin call from your broker in which you need to pay back more than you have available in your account. And during an especially volatile period a gap in price can create execution risks that cause unexpected losses.