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Contract for Difference trading (or CFD trading in short) enables you to speculate on the rising or falling prices of underlying assets, such as company shares, currency pairs, stock indices and precious metals, without having to purchase or own that asset. Instead, you are able to just Buy and Sell CFDs on the price of that asset on an online trading platform or app.
When you trade CFDs you are entering into an agreement to exchange the difference in the price of an asset from the point at which the contract or trade is opened to when it is closed. The profit or loss you make will be dependent on the extent to which your forecast is correct. The appeal of CFDs is that they allow traders to Buy or Sell on the price of different assets, giving them the possibility to benefit from both rising and falling prices, without necessarily investing a big sum, while they can also use leverage to increase the size of their positions.
CFD trading enables you to open larger positions using leverage, which can amplify your gains, but can also amplify your losses. Essentially, you are putting down a fraction of the full value of your trade – and your broker is lending you the rest. Your total exposure compared to your own margin is known as the leverage ratio.
When you open a CFD trade, you select the number of contracts by defining your preferred trade size and then you proceed to choose whether you would like to Buy (speculate that the price is about to move higher) or Sell (speculate that the price is about to move lower). Your potential earnings will rise in line with how much the price moves in your favour, or against you.
The main difference between CFD trading and Shares dealing is that with CFDs, you are speculating on price movements without taking ownership of that said share, while shares dealing requires you to take direct ownership. Another important difference is that CFDs are leveraged products, which means that you only need to deposit a small percentage of the full value of the share CFD in order to place a trade, whereas with traditional share trading, you buy the shares at face value.
CFDs are considered a popular alternative to physical shares dealing for a number of reasons. With CFDs, you never actually Buy or Sell the share that you have chosen to trade, but you are rather speculating that the price is about to move in either direction. CFD trading is often favoured by traders with a short-term outlook, looking to open and close trades within a short timeframe.
One of the key advantages of CFD trading is that you can trade on the price of a product going down as well as up, so you can attempt to benefit from selling as well as buying on the price of an asset. More importantly, CFD trading does not require a big initial investment as it enables you to use leverage to increase your market exposure.
CFDs are also available on a wide range of asset classes, enabling you to diversify your portfolio with everything from forex to shares, indices, metals and more. What is more, CFDs are free from stamp duty and in most countries, CFDs can be used for hedging a non-leveraged investment portfolio.
CFDs are complex products and can carry increased risk due to leverage. While leverage enables you to gain a much larger exposure, by amplifying the size of your trades, it also magnifies the scope for both gains and losses.
With CFDs you are speculating on the price movements of financial assets, such as shares, which are in turn affected by broader market conditions. However, because CFDs are highly leveraged, a little market volatility can go a long way, especially if you are trading during times of economic and political uncertainty.
CFDs are traded on a broad range of assets, essentially, anything that is a “market”, or an index can be used as the basis for trading contracts for difference, and as a result you can access a wide range of different underlying assets including big company shares, currency pairs, cryptocurrencies, commodities and more.
Trading in Forex/CFD carry a high level of risk to your capital due to the volatility of the underlying market. These products may not be suitable for all investors. Therefore, you should ensure that you understand the risks and seek advice from an independent and suitably licensed financial advisor.