There are many different investment options available. Some of them include conventional stocks, bonds, commodities, indices, and Forex. These options fit snugly into a contrarian investment proposition known as a CFD.
Put simply, a CFD is a contract for difference. It is a derivatives trading instrument available through online brokers and it supports a wide range of financial instruments. The benefits of trading a CFD are evident in its pervasiveness as a preferred online trading option. The advent of online brokers boosted the appeal of CFDs in many ways.
The way that most investments work in a traditional sense is as follows:
A client registers at a trading platform or brokerage and purchases stocks, commodities, indices or FX. To generate a profit, there must be an appreciation of the underlying asset. If an asset is purchased at a price of X, it must appreciate by X + Y (a positive number) for profits to be realized. This is also one of the main hindrances to conventional investment paradigms.
How to Generate Profits without Buying Actual Assets?
With CFD trading, profits can be realized in any direction. The clincher is simply calling it right. In other words, the difference between the buy price and the sell price determines whether profits are realized. These are known as the opening price and the closing price of the underlying security.
This allows retail investors to dabble in the financial markets whether they are bullish or bearish and generate profits accordingly. CFD trading is leveraged trading. This means that a small upfront investment amount is required to manage a much larger financial portfolio. This comes with many pros and cons such as enhanced profits, or large losses.
CFDs in Action – a Working Trader’s Guide
CFDs bear many similarities to futures contracts. These agreements between parties dominate institutional trading around the world. With futures contracts, a future date is set between two parties. With futures contracts, the capital outlay is significantly less, and very little expertise is needed to get started.
It is possible to use powerful trading platforms to derive maximum benefit from CFD trading. Remember: With CFD trading, there is no physical asset ownership. It’s simply a speculative assessment of the price movement of the underlying asset. One of the biggest markets for CFDs today is Forex trading. An estimated $4 trillion to $5 trillion in currency pairs trading is undertaken. And a significant chunk of Forex trading takes place in the CFD market.
In response to the question, What is CFD trading – it is perhaps best to provide a working example of how CFDs actually function:
If you have £10,000 in your trading account, and there is 5x leverage, you can effectively trade CFDs valued at £50,000. Remember that leverage cuts both ways. You can generate a profit or loss on that leveraged amount. The margin requirement, in this case, is 20 percent; calculated as follows £10,000/£50,000. If your trade size is 50 lots of 10,000, and you have leverage of 50:1, you can open a total position worth £500,000. If there is a 100 pip loss, that amounts to a loss of £5,000 which is 50 percent of your equity. However, if your total equity is £10,000 and you buy five 10,000 lots for £50,000 with leverage of 5:1, your total £ loss with 100 pips amounts to £500 which amounts to just 5 percent of your total equity.
