What are CFDs? All You Need to Know

Whether you are new to financial investing or simply considering an alternative investment angle, you may have seen adverts promoting “CFDs” online. The term stands for contracts for difference – an arrangement between a broker and a financial trader to exchange the difference between the opening price of a contract and the closing price of a […]

Whether you are new to financial investing or simply considering an alternative investment angle, you may have seen adverts promoting “CFDs” online. The term stands for contracts for difference – an arrangement between a broker and a financial trader to exchange the difference between the opening price of a contract and the closing price of a contract. The use of CFDs allows traders to profit from the movement of thousands of global markets without having to actually own the underlying instrument, which can be fiat currency or commodities such as gold.

Rather than making a physical acquisition of a stock, commodity, foreign currency or government bond, CFD brokers allow financial traders to open a contract designed to replicate the profit and loss they’d make on a physical trade. A CFD is open with a broker until a closing order has been placed – the profit or loss is calculated as the difference between the underlying instrument’s value from the opening and closing order. CFDs have helped people to trade from home, as the BBC’s Millions by the Minute show testifies.

How many markets can you trade with CFDs?

Part of the appeal of CFDs is that you can have direct access to literally thousands of markets, from single stocks, index trackers and forex pairs through to commodities index options and much more. So, whether you’ve heard some news about a company that’s thriving or struggling, or you believe a nation’s economy is facing a turbulent time, opening a CFD order on a stock or currency can be done within a matter of minutes, allowing you to speculate on its value.

What are the costs incurred with CFD trading?

When you choose to trade CFDs, you’ll be required to pay a spread”. This is the difference between the “buy” and “sell” price of an underlying instrument. The smaller the spread, the less the price needs to trend in your favour before you begin to profit from your trade. On the other side of the coin, tighter spreads can also help mitigate losses if a trend moves against you. CFD brokers will also charge holding costs for CFDs open at the end of every trading day. Some CFD brokers will also charge commission on each trade, although some prefer to factor their commission into the size of their spreads.

Typical CFD trading strategies

CFDs are growing in popularity as they allow investors to profit on rising and falling markets. If the value of an underlying instrument is trending upwards, CFD traders can open “long” positions in the hope that the price will continue to rise; meanwhile, underlying instruments trending down give CFD traders an opportunity to “short” it and close the position when the price bottoms out. Generally, CFDs are held for only a matter of days or weeks as opposed to long-term periods. They can also be a useful hedge against other trades to mitigate losses in other areas of your trading portfolio.

In the UK, CFD trading is proving particularly successful as investors do not pay stamp duty on their profits at the time of writing. Put simply, if you’re looking for an easy way to diversify your investment portfolio – with the ability to implement stop losses and take-profit orders too – CFDs can help investors get the most from their trades, with broker leverage allowing traders to maximise their investments on underlying assets.

Of course, with market leverage brings risk, with the chance to significantly increase your losses as well as your gains – something to be aware of before diving in head-first.

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