What is CFD?
A Contract for Difference (CFD) allows you to speculate on the price movement of financial assets without owning them. CFDs are cash-settled, meaning the difference between the opening and closing trade prices is paid out, with no physical delivery of assets. You can trade a range of markets like shares, currencies, commodities, and stock indices. When trading a CFD, you agree to exchange the difference in the asset’s value between the opening and closing of the contract. If you believe the price will rise, you "buy" (go long); if you think it will fall, you "sell" (go short). CFDs are derivatives, meaning their value is based on an underlying asset. Profits or losses depend on how the market moves in relation to your position. CFDs provide the opportunity to profit from both rising and falling markets. However, since you never own the asset, your gains or losses are linked to the price movement, and they can be amplified.
How does CFD work?
When trading CFDs, you’re presented with two prices: the buy (offer) price and the sell (bid) price. For example, if silver is listed at 1650/1653, you can buy at 1653 if you think the price will rise or sell at 1650 if you think it will fall. The difference between the buy and sell price is called the spread. The spread represents a fee charged by the CFD provider, and a narrower spread is more favorable. To close a position, you must take the opposite action—buying to close a sell position and vice versa.
In general, physical settlement is not an option for CFDs. For example, if you bought silver at 1653 and the price rises to 1686, you can sell to lock in a profit, and you cannot request the CFD provider to settle the contract with physical silver. The profit or loss depends on the number of contracts, the contract value per point, and the price movement. Contract sizes vary by asset, and commission or fees may apply.
Why trade CFD?
- Access to Falling Markets: You can profit from allying markets by taking a short position, where you sell the asset you expect to decrease in value.
- Diverse Market Access: CFDs allow you to trade a wide range of global markets on one platform, including stock indices that can't be directly bought or sold.
- 24-Hour Trading: Some CFD providers allow round-the-clock trading on certain markets, giving you the flexibility to trade even when traditional markets are closed.
- Leverage: CFDs are leveraged products, meaning you can control a larger position with a smaller initial deposit. For example, a 5% margin means a $40 deposit could control $800 worth of gold.
Risks Associated with Leverage in CFD Trading
Leverage can enhance your potential profits when trading CFDs, but it’s important to understand the associated risks. Both profits and losses are calculated based on the total value of your position, not just your initial deposit. This means that your losses could exceed your deposit if the market moves unfavorably. While leverage allows you to control larger positions with a smaller investment, it also amplifies both the upside and the downside, making it a significant risk in CFD trading.
Since CFDs are typically traded with a single CFD provider and are not transferable between providers, the credibility of the CFD provider is crucial. Trading Contracts for Difference (CFDs) usually involves dealing with a single CFD provider, and these contracts cannot be transferred between providers. Therefore, the credibility of the CFD provider is essential. It is recommended to trade only with licensed CFD providers, as proper regulations generally impose financial requirements on brokers as part of their licensing obligations.
