How CFD Trading Works

Contract for Difference, or CFD, is a form of trading that relies on the underlying difference in the value of assets at the time of entering and exiting a trade.

As the name clearly suggests, this form of trade works on a contract between two parties – essentially a broker and client – speculating on the movement of price of a given asset.

Returns can be earned for both profit and loss to an underlying asset without having to own it. These features of CFD trading formula have made it an increasingly popular investment proposition in the recent past.

Wondering how to be a successful CFD trader? Learn how CFD trading works to minimize risks and increase your chances of success.

CFD vs Spread Betting: The Key Difference

CFD is in principle similar to spread betting. In both these forms of trading, you can speculate on the difference in value of an asset and earn returns from both rise and fall in asset value, without owning it.

However, the key difference is that spread betting is tax free since it is still considered a form of gambling, CFD, on the other hand, only enjoys exemption from stamp duty.

Trade Features for CFD

The biggest highlight of this form of trading is that a person speculating on an asset does not own it. This means you can earn big returns from a given asset without a substantial initial investment.

A token deposit made with the broker, which can be anywhere between 5 and 20 percent of the underlying cost of the asset, is all it takes to begin trading.

This frees up your capital, thereby minimizing risk of monetary loss, and also opens up the option to speculate on different assets at the same time with a limited capital.

The other key feature of CFD is the ability to earn profits with not only an increase in prices of assets but also a decrease.

This is referred to as long and short trade. When you open a CFD trade with a ‘buy order’, it is long trade, and when you go by a ‘sell order’, it is short trade.

In addition to these key highlights, some of the other major advantages of CFD include:

• CFD trade speculations are not just limited to stocks. You can trade on a wide range of assets such as commodities, currencies, global indices, and sectors.
• CFD does not come with an expiry date. You can continue to speculate on the same asset as long as there are sufficient margins available. The financial position on a given asset is calculated at the end of each trading day.
• As long as the trade on a given asset is open, your account will be credited or debited on a daily basis depending on the trading value of the day vis-à-vis your trading position.
• Even though you can enter CFD trading by investing what is known as the margin amount, you deal with cash movements on the asset’s actual market price.
• You can close trade on an asset at any time by simple reversing your trading position. For instance, if you were going long on an asset, you can close trade on it by going short.

CFD is a great avenue to make a quick buck but it comes with its own share of risks and pitfalls. It is important to understand the risks and learn the rope before taking a plunge.