A CFD acts as a contract to exchange the difference in value of a financial instrument between the time that the contract was opened and the time it was closed. With CFD trading, you never own the underlying instrument, you are only speculating on its price movement.
What is a CFD?
CFDs are a form of derivative trading. A CFD is a tradable instrument that mirrors the movements of the asset underlying it. When you take a position, the value of the asset will move in relation to that position. The contract allows profits or losses to be made from these movements.
With a CFD, you never own the asset in question. Instead, it is a contract between the client (you) and the broker. With CFD trading, you can trade on the margin, and you can go long (buy) if you think prices will rise, or short (sell) if you think they’ll fall.
What is a CFD trade?A CFD trade allows you to speculate on whether the price of an asset will rise or fall. You can speculate on a number of markets and instruments, including shares, commodities, indices, currencies and treasuries.
When you open a CFD position, you select the amount of CFDs you’d like to trade.
For every point the price moves in your favour, you will gain multiples of the number of CFD units you have bought or sold. For every point the price moves against you, you will make a loss. When trading CFDs, it’s important to know that your losses can exceed your original deposit.
If you think the price of the market will rise, you ‘buy’. If you think the price of the market will fall, you ‘sell’. Then, if you’re correct, your profits will rise in line with any price increase/ decrease. However, if you’re incorrect, you will make the equivalent loss.
What Are CFDs Stop Loss Orders?One of the best ways to limit the risks associated with CFD trading is to set stop-loss orders. These are essentially orders which guarantee a CFD position will be closed below the market price at the time, and help to prevent investors losing too much money on a single trade.
They can be an incredibly useful tool, and often make trading CFDs a far less daunting task, given the extra security they provide for each trade.
What is CFD Hedging?Some investors use CFDs to hedge their investment portfolio against overall risk. If they have a long-term investment, for example, which they believe will be profitable in the long term but may sink short term, a CFD against that asset may help to offset the initial losses.
This is an effective strategy when considering how to make an investment portfolio more diverse, as it can effectively balance investments out.
How to Get Started with CFD TradingTo begin trading CFDs, all you need to do is create an online account and you can start trading straight away. It is worth remembering that losses can exceed deposits, especially with leveraged investments, so it is best to be well clued up about how to manage investment risk accordingly.
It is possible to make consistent profits from CFD investments, but only if you have researched the assets/instruments you are investing in and based your investment decisions on logic rather than emotion. Constructing a well developed, comprehensive trading strategy is the best way of approaching CFD trading, and will help you on your way to success.