CFD trading is a special kind of trading that makes it possible for you to trade an asset without owning that asset. CFD stands for Contract for Difference. It enables you to speculate on the financial market without you having to own the asset. So, you can buy or sell the asset hassle-free. One of the major benefits of CFD trading is that you can trade both when the value of that asset rises and falls. This means you can buy when the asset falls in value and sell when the asset rises in value. So, you can make a profit both ways.
In CFD trading, the trader does not deal on the underlying market itself but the prices from the underlying market. Thanks to CFD trading, the trader can have access to leverage. The leverage will enable you to open trading positions bigger than your account balance. This is possible with the use of leverage. CFD trading also helps the trader to make a profit irrespective of the direction of the asset, be it buying or selling. You can easily trade a large number of markets when you trade CFD. If you like, you can also opt for the use of DMA. You can even go further to hedge a share portfolio in CFD trading. This can help to cut down your losses a great deal.
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In the remaining part of this write-up, we will show you a couple of interesting things about CFD trading.
What CFD trading stands for?
CFD trading is the buying and selling of CFDs. As we mentioned earlier, CFD stands for Contract for Difference. CFD makes it possible for the trader to speculate on financial markets. Examples of such financial markets are commodities, indices, Forex, and shares. You can trade all these assets without having to own any of the assets. So, CFD helps to reduce the cost of trading. When you trade CFD, you are automatically agreeing with the broker to exchange the price difference of an asset from the entry point to the exit point. As we mentioned earlier, you can speculate on either direction when you trade CFD. You can make a profit when you buy or sell the asset and vice versa. You will make a profit if your speculations or forecast is correct and vice versa.
Short and long trading
CFD trading can be categorized into long and short CFD trading. Like we mentioned earlier, you can speculate in either direction when you trade CFD. When you buy an asset in CFD trading, you are going “long”. When you sell the asset, you are going “short”.
Take apple shares for example. If you forecast that the value will rise, you can buy the asset or “go long”. If you forecast that its value will fall, you can “go short” or sell the asset. You can do either of these without ever owning Apple shares physically. So, you can make a profit or loss, irrespective of the direction of the price movement of that asset. If the asset moves in the direction you predicted earlier, then you will make a profit by the time the position closes.
Using leverage in CFD
One other feature every CFD trader must consider is leverage. When you use leverage, you will be able to control a large position with a very small amount of money. This means that you will not need to commit the entire cost of opening the position to that trade. The remaining amount will come from the broker in form of a loan. The size of the position you can open depends on the amount of leverage you use. If you use a leverage of 50:1, for example, it means that you can open a position 50 times bigger than your account balance can accept. If you have about $1000 in your CFD trading account, it means that you can control a position of $50,000 with leverage of 50:1.
The use of leverage can increase the amount you can make as a profit. At the same time, leverage can increase the amount you record as a loss. So, you should see leverage as a two-edged sword. It can help you to make a huge profit and also cause you to make a huge loss. So, you should use leverage with care. Leverage can magnify both profit and loss. You should avoid overleveraging your account when you trade CFD.
You do not have to issue leverage before you can trade CFD. In fact, you can get brokers that will not force you to use leverage. Be that as it may, some brokers make it a must for traders to use leverage. The liquidity and volatility of the asset can determine the leverage the broker offers. The legislation in your country can also determine the leverage you can use.
Margin in CFD trading
People do refer to leverage as trading on margin. This is because the funds you need for opening and maintaining a position stand for only a fraction of the total size of the position. This fund is also the margin. There are two types of margins in CFD trading. They are:
- Deposit margin
- Maintenance margin
Deposit margin is the fund you need for opening that trading position. The maintenance margin, on the other hand, is the fund you need if the trade moves close to losses that the deposit margin will not be able to cover. The broker can give you a margin call once your trade nears the maintenance margin. The margin call is to inform you to add more funds to your trading account. If you fail to add more funds, the position may close in loss and you will not be able to make another trade until you add more funds.
Hedging in CFD trading
You can use CFD for hedging the market against losses in an existing portfolio. If you feel that the shares of a company will lose value in the short term. You can decide to go short in the meantime. You can do this if you are already going long on that same asset. This way, the drop in value will automatically offset the loss you recorded as a result of the buy trading decision.
When you want to hedge in CFD trading, open a position that will record profit if any of your current positions starts to bring loss. The new position will help to offset the loss that the initial position can record.
How CFD works
In this section of the write-up, we will show you how CFD works. There are 4 concepts behind CFD trading. These concepts are:
- Del size
The price quotations on CFDs are two, which are the buy price and sell price. The selling price is also called the bid price. It is the price at which the trader can open a short CFD. On the other hand, the buy price is also called the offer price or ask price. It is the price at which the trader can open a long CFD.
The bid price will always be lower than the offer price in CFD trading. The difference between the bid and ask prices is the spread. The spread covers the cost of opening a trading position. As a result of this, the buy and sell prices will get adjusted so that they can show the cost for making that trade.
Share CFD is the exception to this. The charge you pay in share CFD is not covered by the spread. Instead of this, the buy and sell prices will match the price of the particular market. The charge is via commission payment. When a commission is used, share CFD price speculation will be closer to buying and selling shares in the market.
Size of deal
CFD trading occurs in standardized contacts also called lots. The lot size differs from one asset to another. The lot size mimics how a particular asset is traded on the market. The contract size in share CFD is represented by one share in the company being traded. This makes CFD trading to be similar to what happens in traditional trading.
Many of the CFD trades do not have a fixed expiry. This is unlike what you get in options. Instead, you can close a position when you place a trade opposite to the one you have opened. If you leave a daily CFD position open beyond a day, you will have to pay a swap. The swap fee is an overnight charge. The cost stand for the cost of the capital you get from your broker called the leverage. The case is not always like this and it differs in a forward contract. A forward contract will come with an expiry date in the future. The overnight charge is already included.
Profit and loss
For you to get the profit or loss you get from any CFD trade, you need to multiply the total number of contracts by the value of each of the contracts. You should then multiply what you get by the spread between the prices. You can get this by subtracting the price when the position opens from the price when it closes.