CFD stands for Contract for Differences. CFD trading gives traders an opportunity to make profits upon price movements of the securities, without directly owning the underlying assets. The securities can be shares, commodities, currencies, or indices, and the calculation is made merely based on the entry and exit prices, who correlate to the underlying value of the asset.
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In essence, traders do not buy an actual share or right to own a commodity during CFD trading; instead, they enter a contract with a CFD broker. Such a CFD contract would have three parameters only:
- Underlying security
- Entry price
- Direction (long/short)
Once such a contract is implemented, in the click of a button, the trader and the broker enter opposite sides of the same trade.
If the price of the security moves in trader’s favor, he gains the difference between the price in which he entered the position and the price in which he exited it. However, if the price goes against the trader, he loses the equivalent amount.
The most significant advantage of CFD trading is that it is leveraged. Traders need to deposit only a small percentage of the trade value to open a position. This helps to magnify the returns while losses are limited.
For example, if a trader expects the price of stock ABC to go up, he can buy 10 CFDs at the current price of, say, $100. If the price goes up by 20 points to $120 he will make a profit of 10*20= $200. Similarly, if the price of oil drops down by 20 points, he will make a loss of $200.
CFD Trading Benefits
CFD trading is exciting and holds good potential, especially for new traders. It allows traders to trade without much capital and without owning the underlying asset. The most significant advantages of CFD trading are:
- High Leverage: The most remarkable characteristic of CFD trading is that it does not require a lot of capital. CFDs offer much higher leverage than traditional products. This means that new traders can start with less capital and generate high returns. However, keep in mind that high leverage can also magnify losses.
- Low Fees: Most of the CFD brokers charge little commissions or fees. Brokers only add a small markup to the CFD spread, i.e., the difference between the buy price and sell price. Also, since traders do not actually own the underlying assets, there are no exchange fees.
- Little-to-No Rules on Shorting: As traders do not need to own the underlying securities for CFD trading, CFDs can be shorted at any time without borrowing.
- Variety of Opportunities: CFD trading permits traders to trade a variety of instruments off the same trading platform. A wide array of products, across all the major markets of the world, are available to trade.
- Flexibility: CFD trading is highly flexible. Traders can trade in any market condition and are allowed to open both long and short positions to trade on rising or falling markets.
CFD Trading Coverage
Coverage refers to the protection offered by the brokers to the CFD traders. It is the insurance provided against price movements in the opposite direction. CFD trading is leveraged and margined, so the traders can put in a small amount of money and also get the required coverage from the brokers.
Due to the leveraged nature of CFD trading, brokers might raise coverage to protect themselves against unexpected price fluctuations. If the market moves in a way that risks the CFD broker, hedging would kick in, to protect the broker. Such hedging takes place when the broker buys the underlying asset so that he is not exposed to the price fluctuation. In such cases, CFD brokers effectively become stock brokers.
CFD Trading and Tradenet
CFD trading is a fast-moving process and is ideal for aspiring traders to begin trading. However, there are significant risks associated with it as well. The high leverage can also translate to huge losses if the trade does not go in the intended direction. Therefore, before beginning to trade, aspiring traders can start with the education packages offered by Tradenet to know the basics.
Tradenet’s Intro Program is an ideal platform to start. It includes all that a trader needs to get started, including a self-study course, access to live trading room, access to Meir Barak’s best-selling trading book, The Market Whisperer, and a demo training account.
New traders can also take Tradenet’s 5-day demo challenge. Traders who become successful at the demo challenge will gain access to a live funded CFD account!
As a bottom line, CFD trading is an effective way for aspiring traders to start trading. The new traders can join Tradenet and benefit from the education, demo challenge, live trading room, and be eligible to apply for a funded CFD account.