What is CFD Trading and How Does it Works

Posted by Brigham on March 2nd, 2017

If you have heard about derivatives, you have probably also heard about CFD trading. A CFD (Contract for Difference) is a special kind of derivative instrument that obtains it value from its underlying asset. CFDs allow you to make potential gains from the price movements of a wide range of assets including stocks, currencies, commodities, indices, and treasuries. This type of trading has become very popular in the online financial markets because CFD trading offers a number of advantages specifically to the trader.

The ability to trade on margin is what makes CFDs very attractive. The required margins are usually very low (2-5%), compared to traditional trading where much larger margins (50%) are usually required. This gives the trader the ability to achieve more with a smaller investment. Other features that make CFDs attractive include the ability to go short or long depending on how you think market prices might move. A CFD may also be used as a hedge for existing portfolios.

With CFD trading, the trader does not purchase the actual underlying asset, but the CFD. He or she takes a position on whether the price of the underlying asset will go up or down and buys or sells accordingly. As the price of the underlying asset increases, you earn multiples of the number of units bought. However, if the price decreases, your units bought are also decreasing in multiples. This happens because of leverage and the fact that you can purchase CFD units on margin. Therefore, you have the potential to earn great returns. On the other hand, you could lose quite a bit if the underlying asset price moves contrary to the position you had taken. The key is to study the market trends in order to accurately predict in which direction the price of the underlying asset will move.