Contract for Difference (CFD) Trading: What it Means and How it Works?

Before trading cryptocurrencies, stocks, and other financial assets, traders need to have those assets in their possession before selling. However, there is another form of trading that does not require having the real assets before buying or selling can take place. It is known as CFD trading, which this guide will discuss, including its meaning and how it works.

CFD Trading: What it Means

A financial instrument famous among traders in the finance industry is the contract for difference, which allows profit-making after correctly presuming the value of a financial asset over a period. It involves trading on the increase or decrease in the value of the assets, mostly over a limited period without the real asset being in the trader’s possession. The difference between the price of the product when the market opens and closes will determine a CFD’s value. 

Traders make profits by selling high after purchasing low, and vice versa. CFD trading is possible on multiple platforms, and its availability can be as indices, shares, bonds, cryptocurrencies, and precious elements. Opening positions larger than the initial amount the traders have is possible through leverage trading, which contract for difference allows. The traders’ wins can increase by trading on margin, amplifying their losses.

CFD Trading: How it Works?

The disparity between the product’s value when the market opens and closes will determine the contract for difference’s value. Traders profit by selling high after buying low and will not own the real asset. When the traders’ prediction indicates that there will be an increase in the value of the product, the trader executes a buy order. The trader makes profits if the asset value increases as predicted. However, when the prediction of the traders indicates that there will be a decrease in the product’s value, the trader executes a sell order and gains if the prediction comes true.

Meaning of Leverage in CFD Trading? 

CFD trading involves trading on leverage which implies that the broker will lend the trader money used to enter a market. The trader’s initial capital will be less than the amount that will be used to place trade eventually. 

Margin trading is another name for this type of trading, and the margin at which traders are trading is the amount they will need to deposit, whereas the broker will cover the remaining amount to complete it. For instance, when a trader uses a leverage of 10% to trade an asset worth $1,000, the only amount the trader needs to deposit is $100. The broker will lend the trader the remaining $900.

Costs Involved in Contract for Difference (CFD) Trading

Spread: The disparity between the purchasing and selling value is known as the spread, and contracts for different traders need to pay it. Traders begin to gain once the value starts moving in the predicted direction due to the narrow spread. However, the traders suffer losses when the price movement is against them.

  1. Holding costs: Once the market closes for a day and the traders still hold positions, there will be a need to pay for the contract for difference holding cost. The asset’s direction will determine the sign of the holding cost, either positive or negative.
  2. Market data fees: Activating the appropriate market subscription at a specific fee will provide the traders with price viewing data for contract for difference. 
  3. Commission: When trading share contracts for difference, there is a need for the traders to pay a commission whose amount depends on the broker. For instance, some brokers may charge a 0.10% commission for opening a position with a contract for difference. 

Final Thoughts 

Some traders are skeptical about CFD trading at different trading platforms due to its lack of regulations which is why the US does not allow contract for difference trading. Contract for difference traders must register with reputable and credible brokers to ensure their safety and security. CFD trading does not have an expiry date, so traders can keep holding on to their positions for as long as possible. Also, trading contract for difference is mostly free, although some brokers may charge a few commissions.

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