A contract for difference (CFD) is a derivatives product, which means that you do not directly own the underlying asset which is being traded. Rather than actually having a stake in certain stocks, currencies, commodities or other investment opportunities and physically owning them, you are merely trading on the movement of underlying prices.
This is a more flexible way to trade many different markets and they hold a number of advantages for both new and experienced traders. If you’re interested in this method of investments, then we have CFD trading explained in detail below.
What is a CFD?
As a good CFD definition, a contract for difference is an agreement between two parties where the difference between the opening and closing price of a contract is exchanged. The difference between where a trade is entered and exited is the CFD. These can be used to speculate on the future price movements of the underlying assets, whether they are currencies, commodities, stocks or anything else.
For example, a CFD works by a CFD trade being entered with a small margin where the position will show a loss equal to the size of the spread. The underlying asset needs to appreciate to match this spread and break even as a trade-off. The trader then has to exit the CFD trade when it meets the bid price.
One of the main advantages of CFD trading is that they are traded on leverage, with higher leverage provided than traditional trading. As little as a 2% margin is required in some cases, though they can increase to around 20% elsewhere. This means less initial capital is needed to begin trading, increasing potential profits but also losses.
Go Long or Short
Another important point when understanding what are CFDs is that you can profit from market movements whether they go up or down. If you believe certain market prices will fall then you can go short (sell), or if you think they will rise then you can go long (buy). With CFD explained this way it means that you can profit from market movements in any direction.
A CFD can be used to hedge other investment portfolios due to this too. If you think some of your existing portfolio will drop in value, then go short in an attempt to offset some of the predicted loss. This is a useful hedging technique, especially in volatile markets.
CFDs on thousands of individual markets can be traded, which makes it a great option for diversifying any portfolio. Plus, as a derivative product you do not have to pay stamp duty when trading CFDs as you don’t own the underlying instrument, saving 0.5% on the value of each trade in the UK.
Our CFD definition should make it easier to understand this method of trading, and if you want to diversify your investment options then begin CFD trading at Sharp Trader today.