Understanding Contract for Difference Trading

The Contract for difference (CFD) isn’t a new form of trading. CFD involves an agreement between two parties to exchange the cost difference between the opening and closing prices of what is referred to as a contract. CFDs provide traders with a great deal of trading flexibility. As a merchant, you only speculate the price movements of hundreds of financial markets regardless of whether the price is going up or falling. While trading on a CFD market, you can decide to go long (buy) and make profits when the prices rise or go short (sell) and still make a profit when the prices drop. You can trade on a number CFD markets such as shares, securities, Forex and even physical commodities such as oil and gold.

You can also use CFD as a leverage tool. It gives you the ability to maximise your market exposure for a small segment of the investment you would need to trade the identified asset directly. For you to open a trading option, you only need to deposit a small percentage of the full value of the deal. This is commonly referred to as trading on margin. Trading on margins is two-way traffic. It allows you to magnify on your returns, but it also increases your losses because the whole transaction is based on the full value of your CFD position. This means that you may end up losing more than what you deposited.

How does CFD work? 

In CFD trading, you don’t buy or sell the actual asset. You only buy or sell a specific number of units for a specific instrument of trade depending on whether you think prices will shoot up or go down. It is more of a zero-sum game in practice. This implies that for every price of the instrument that moves in your favour, you gain multiple values of the number of CFD units you bought or sold. For every instance that the price moves against you, you end up making a loss. You open a CFD position by selecting the amount you would like to trade for a particular asset. If you have a feeling that the market price of your chosen market will shoot up, you go for the buy option and your profits will rise as the price of your selected market increases. On the contrary, if the price of your selected market drops, you make a loss for every point it moves against you.

Is CFD trading good for you? 

If you are after an opportunity to make a better return on investment, then you can try CFD trading. You should also keep in mind that CFD trading is just like any other form of trading and it is associated with risks. You should try to trade on simulators before going live on the market to limit the risk of losing your money. Generally; CFD trading is suitable for the following individuals;

  • If you are looking to diversify your portfolio. Remember that there are over 5,000 global markets that you can trade on. The markets include Forex, shares, indices, and commodities
  • If you are after short-term investment opportunities. Typically, CFDs are held for a few days to a week. It is a short-term investment rather than long-term.
  • If you want to an active or passive trader. With CFD, you can trade as little or as often as you want.


Hedging with CFDs 

CFDs are often used as hedging tools. With CFD, you can decide to go short (sell) when the market prices are falling. Investors usually take advantage of this scenario to offset losses made in their portfolios. If you have a long-term asset that you wish to keep, but you have that feeling that there is a short-term risk to the actual value of your investments, you can choose to use CFD to mitigate the short term risk by hedging your position. If the real value of your portfolio falls, you would have made a profit on CFD which can help you in offsetting the losses incurred.

To stay ahead of the game, you need to constantly update yourself with the changing forces in the market in order to determine how you will trade. There is a lot of information online such as from CMC Markets site that will help you in making decisions when trading.