CFD (contract for difference) trading is a popular option for traders all over the world. But what does it mean, how does it work, and what benefits does it offer?
Contract for difference (CFD) explained
Traders can leverage CFDs to speculate on the movement of prices without needing to take ownership of an underlying asset (such as a currency pair or commodities) itself.
The aim is to predict an increase or decrease in the asset’s value correctly: you either sell (“go short”) or buy (“go long”) depending on the change you expect to see over a set period of time.
In CFD trading, investors calculate their profits and losses by assessing the difference in an asset’s price between the start and end of the contract, multiplied by the amount of CFD units involved.
The broker you enter into the agreement with will compensate you if the value of that difference works in your favour. But if your forecast is inaccurate and leads to a loss, you will pay the broker the difference instead.
What role does leverage play in CFD trading?
“Leverage” is a vital term in CFD trading: leveraging allows you to invest without needing to pay the full cost of the asset itself. Just a small amount of the overall trade value is required as a deposit (much smaller than in traditional trading) — allowing for potentially higher returns on your investment.
Obviously, there’s also a risk of paying more if you end up with a loss, which is why working with a trustworthy CFD broker is so important. Find a broker with a solid reputation, and you’re more likely to enjoy a positive outcome on your CFD trades.
Traders should always take care to make sound investments that fit their budget comfortably — a good broker minimizes risks and maximizes performance.
Understanding CFD costs
Keep the following costs in mind when you try CFD trading for yourself for the first time:
- Holding costs: this applies to the charge made on any positions in your account which remain open by the close of the trading day. Holding costs may be good or bad — it depends on the movement direction and the holding rate involved. Day traders avoid allowing their positions to stay open throughout the night.
- Spread: the spread in CFD trading refers to the difference between a buying and selling price — the narrower the spread, the less movement a price has to make in your favour before you can generate profit.
A good, reliable CFD broker will be happy to explain these (and any other costs) to you carefully.
Can CFDs expire?
On the majority of markets, CFD positions have no expiry date: they can stay open for as long as you feel necessary. Ideal periods will vary based on your trading goals and situation.
There’s a lot to consider when trying CFD trading for the first time. But taking the time to find a seasoned broker can help you get off to a stronger start and achieve positive results down the line.