Understanding CFD Trading

(CFD) is an acronym for Contracts for Difference. CFD is an innovative financial instrument that provides you all the advantages of buying a particular stock, index or commodity position – without having to physically or legally own the underlying asset itself. It’s a manageable and cost-effective investment vehicle, which enables you to trade on the fluctuation at the price of multiple commodities and equity markets, with leverage and direct execution. As a trader you enter into a contract for a CFD at the quoted price and the difference between that opening price and the closing price when you chose to end the trade is settled in cash – therefore the term “Contract for Difference”
CFDs are traded on margin. This means that you are geared to leverage your investment by opening positions of larger volume than the funds you have to deposit as a margin collateral. The margin is the amount reserved on your trading account to meet any potential losses from an open CFD position.
Example: a big company expects a record result and you think the price of the company’s stock will rise. You decide to buy 100 units at an opening price of 595. If the price goes up, say from 595 to 600, you will get a gain of 500. (600-595)x100 = 500

Buying in a rising market
If you buy an asset you predict will rise in value, and your forecast is right, you can sell the asset for a profit. If you are wrong in your analysis and the values fall, you have a potential loss.

Sell in a falling market
If you sell an asset that you forecast will fall in value, and your analysis is correct, you can buy the product back at a lower price for a profit. If you’re wrong and the price rises, however, you will get a loss on the position.

Trading on margin
CFD is a geared financial instrument, which means that you only need to use a small percentage of the total value of the position to make a trade. Margin rate with a CFD broker may vary between 0.20% and 20% depending on the asset and the regulation in your country. It is possible to lose more than originally deposit so it is important that you understand what the full exposure and that you use risk management tools such as stop loss, take profit, stop entry orders, stop loss or boundary to control trades in an efficient manner.

CFD prices are displayed in pairs, buying and selling rates. Spread is the difference between these two rates. If you think the price is going to drop, use the selling price. If you think it will go up, use the purchase price. For example, look at the S&P 500, it may look like this:

Buy 2398.68 / Sell 2398.08

Spread Per Unit 0.60 USD Spread (%) 0.0250 %

You can find an overview of the costs associated with CFD transactions under transaction costs.