CFD trading, otherwise known as contract for difference trading is the process of taking a position the value of a contract that mirrors the value of a stock or commodity.
People have been trading CFDs for the past 15 years and it continues to increase in popularity. The development of high speed internet has allowed this type of market to open up and gain the recognition that it has today. There are many advantages and reasons why people prefer trading CFDs over buying and selling stocks or other forms of investments. Below, we will go over many of these reasons for you.
CFD Trading Works Similarly to Share Dealing
Just like buying and selling a share, you can buy or sell a CFD. You can also short a CFD in the same way that you would with shares. The price of the CFD will fluctuate based on a number of factors in the same way that the price of the stock of a company would.
Going Long on a CFD
If you think the CFD will go up, you should buy it. This is called going long. If the price is higher when you sell it than when you first bought it, you will make a profit on the trade. If the price is lower when you sell it than when you first bought it, you will take a loss on the trade.
Shorting a CFD
You can sell a CFD upfront if you think it will decrease in price. This is called going short. When you take a short position, you must ‘buy’ it back in the future to close your position. This is called buying to cover.
If the price is lower when you cover it than when you first shorted it, you will make a profit on the trade. If the price is higher when you cover it than when you first shorted it, you will take a loss on the trade.
If you are familiar with trading stocks, you should already see how similarly trading CFDs are to trading shares on the stock market.
What Is The Difference?
The main difference between a CFD and a stock is that you don’t have to actually purchase and sell a portion of the company that is being traded like you do if you buy a share of a company. Instead, it is a position that you are taking that is based on the value of the stock as opposed to buying the stock itself. This allows you to have greater flexibility over what you can do with it.
To put it another way:
When you buy a share, you are buying a very small portion of the company. After the share has been bought, you actually own that small portion of the company.
When you buy a CFD, you are taking a position that mirrors the price of the share without actually purchasing the portion of the company. For this reason, the value of the CFD will not be realized until you sell the CFD and close out your position.
Leverage:
CFD trading gives you more leverage with the money that you have in your account. You will typically be able to leverage your funds up to 10 times the amount that you have to invest. This means that you will be able to multiply the profits that you can make with each position you take.
What Can I Trade With CFDs?
You can use CFDs to trade on a number of other markets including indices, foreign exchanges, commodities, treasuries, shares and more. Whatever market you are targeting with a CFD, your goal remains the same: buy low and sell high. Doing this successfully will allow you to generate profits that you can continue to invest and grow over time. This is one of the main draws that have contributed to the increased popularity of CFD trading.