CFD Trading Explained
If you’re interested in investing, you may have come across the term. If you haven’t, then it’s an investment you may wish to consider. Let’s start by deconstructing the acronym. It stands for “Contracts For Difference", and the essence of the investment is that allows you to trade in assets you don’t actually own.
If that made you raise a curious eyebrow, then keep reading, and we’ll tell you how it works.
How not to pay so much for your investment
First, consider stock, or share trading. You buy a share of stock through your broker, or some online service, and you own it. You paid the full, current asking price for it, plus a commission. Your profit or loss is dependent on what the stock price does, minus more commissions when you sell.
The problem with that approach is, of course, that you’ve got to have the money on hand to pay the full, current asking price for the stock, times however many shares you purchase. Sure, you can open a margin account, but most of these require at least a 50% margin, so it can still be quite expensive.
CFD Trading isn’t like that. You can buy a contract that tracks the price movements of the underlying asset, and you can do it much more inexpensively than you could if you had to shell out the full share price. Generally, you’ll find CFD margins to be in the neighborhood of 5%. To put some real numbers behind that, and to keep it simple, let’s say you bought 1000 shares of a stock priced at $10 a share. Even with a 50% margin account, you’re looking at $5,000 out of pocket, plus brokerage fees.
But since the CFD margin is typically only 5%, you could make the same transaction for only $500 out of pocket. Sound too good to be true? Well, yes and no. There are some huge advantages to investing in this manner, the most obvious of which is that you’re increasing your leverage. That can lead to much better rates of return than you’d otherwise see, but if the stock price moves in the opposite direction, it can also magnify your losses, so care and due diligence are a must.
CFD trading offers other advantages as well. For one thing, there aren’t nearly as many fees as you’ll find when dealing with a broker making a “regular” trade purchase. Brokers who deal in Commodity, Index and Forex CFDs make their money on “the spread,” not by charging you a commission for every little thing, and that can add up to pretty impressive savings over time.
A major advantage is that trading CFDs allows the trader to trade long or short. Being able to trade both sides of a market is the real edge that CFDs deliver. They enable you to protect stocks you may be holding in a falling market: trade the same stock short to cover the losses your stocks accumulate.
Another advantage worth considering is that there aren’t nearly as many regulations where CFD trading is concerned. That, of course, can be a bit of a two-edged sword, because in the absence of those regulations, you need to take extra care to find a broker you know and trust. Those relationships take time to build, but the important thing to remember here is that these brokers live and die by the way they treat there customers, so while there are undoubtedly a few unsavory types out there, just as there are in every business, the bottom line is that a broker who mistreats his clients isn’t going to be a broker for very long. All that is to say that the fears of rogue, opportunistic brokers, while containing a grain of truth, no doubt, are somewhat overblown, and mostly designed to scare potential investors off.
Finally, consider that most CFD brokers actually offer products in all the world’s major markets. Consider this then, to be akin to “one stop shopping.” There’s no need to set up accounts in multiple places, and develop and maintain relationships with a variety of brokers to get access and exposure to the full range of investments that the world’s markets have to offer. You can do it all from a single, centralized point, and there’s a lot to like about that.
CFD brokers offer many of the same ordering types that traditional brokers do, including contingent orders, such as “if dones” and “one cancels the other.” You’ll even find that some brokers have guarantee stops, although in these cases you will find that most charge a nominal fee for the service.
The point here though, is that CFDs offer you all the same advantages as buying stocks outright, with many additional advantages besides, not the least of which is the promise of greater returns through greater leverage.
Are there risks? Absolutely. Anyone who tells you that you can invest totally risk free is probably trying to sell you something. Risk is simply part of the investing landscape, but CFDs are an attractive, powerful option that you would do well to consider.
CFD trading offers great flexibility
So, Contracts For Difference are a derivative, covering most markets - Stocks, Forex, Commodities, Bonds, Indices, Notes and Interest Rates and, through your CFD provider you will have access to a huge range of trading opportunities.
PLUS, TradingLounge covers most of these products in terms of daily trade signals and technical analysis!
CFDs are leveraged products and should be approached with respect, meaning you need to have a good grip on money management, otherwise you will lose your capital quickly. After all it's a numbers game and we teach you this concept.
If you’re new to CFD Trading then it’s recommended you do the CFD Trading Certificate as it covers the basics of CFD Trading.
Download the free CFD Book from this page.
This CFD eBook covers the basic mechanics of CFDs and it’s a good, clean informative read.