CFD is the abbreviation for; contract for difference. Explained in simpler words, CFD trading is an agreement to exchange the difference between the price of an asset as at during the opening of the market and that which it is sold at during the closing of the market.
How CFD Trading Works
In CFD trading, the trader does not have to buy or sell the asset (can be an asset or a currency pair) whose price is in question. A trader participates in this trade by buying or selling the number of units of the particular difference depending on the prediction of whether the prices will go down or up.
There are different CFD instruments on different markets. Examples of the most popular CFD instruments include; currency pairs, shares, stock indices, treasuries and commodities.
In CFD trading, a trader makes profits equivalent to the number of times the price of the underlying commodity moves in his/her favour multiplied by the number of CFD units that have been bought or sold. Losses occur each time the point of the price moves against a trader’s prediction. It is possible to accrue losses that will exceed the amount of initial capital made in deposits.
Margins and Leverage
CFD trades are normally leveraged. What does this mean? That you do not have to make a deposit of the entire trade value in order to make a trade, you can proceed to open a position after making a certain percentage of the whole value. This technique is referred to as trading on the margin requirement. As much as trading on the margin magnifies the possible returns, it also has the same impact on possible losses. This is because it is like a sword that cuts on both sides, yes you can make a profit if the trade ends well in your favour, but you could also end up losing much more than the initial deposit because if a loss happens to occur, they are also magnified.
Different Costs of CFD Trading
Holding costs are the charges imposed on any CFD trading positions that are still open in a traders account by the end of each day. The holding cost can either lead to a profit or loss but this largely depends on the trend of the position as at the end of the trading day.
Spread is the difference between the buying and selling price of an underlying asset. To participate in CFD trading, one must pay the spread. One enters a trade using a quoted buying price and only exits using the set selling price. If a spread is narrow, then the chances of making profits are higher because, ideally, all that is required is covering the small difference before the price begins moving in your favour. If you are unsure about the position to take, you can get competitive spreads from forex brokers who will help you establish yourself until you are comfortable in the cfd market.
Commissions are only charged when a trader does CFD trading in shares. Commissions on share CFDs are calculated as a percentage of the full exposure of a trade position, for instance, it is 0.10% for commission on UK shares. Share CFDs attract a commission fee during the opening and closing of the trade.
Identifying the Best CFD Trading Platform
If you are a beginner, CFD trading might seem like a very complex trade mechanism but with a friendly platform, you can have most of your needs met and in an excellent way. Here are some things to look out for;
- Ease-of-use platform; the best CFD trading platform is one through which traders are able to know their way around without a hassle.
- The platform should have support provisions like market analysis, account management options, data entry or cancellation options and so on.
- A great platform should also provide traders with regular real-time highlights of trade trends.