A contract for difference (CFD) is an agreement for the exchange of the difference in the value of a currency, equity stock, or a commodity product between the times in which the contract is valid. CFD trading is the new, easier, flexible, and far more sophisticated way to invest your capital.
CFD trading is a geared product and provides investors firms like CMC Markets with unprecedented trading leverage opportunities. Designed as a financial derivative, a CFD gives the investor the potential to invest in a wide array of investment tools in a variety of markets. With CFDs, the trader can discover profits by trading on the price movements of securities and indices. It also enables the trader to invest in different market conditions and makes it easier to hedge positions.
CFDs provide a flexible platform for trading in various commodities including foreign exchange. A trader can make profits in two ways – buying a currency when it is expected to appreciate or selling when its value depreciation is anticipated. Forex trading with CFDs allows the trader to consider the buying price as the base price. The trader need not worry about the least or the maximum value of the currency pair. As CFDs are highly leveraged products, the trader can open positions that are almost 20 times the margin money deposited. Sometimes the leverage options can go as high as 500 to 1. One should be wary of opening up highly leveraged positions which may be difficult to cover. It may result in diminishing the initial capital.
CFDs are subjected to an alternative tax treatment as it does not result in the actual acquisition of the underlying instrument being traded. The trader receives only a contract, similar to the futures.
CFD trading is gaining popularity with investors across the world. This is because of the ease and flexibility of operations and the variety of instruments on which a trader can trade with a contract for difference.
CFD Trading – How Can You Profit By Short Selling?
Short selling in CFD trading is a technique to make money when the price of share falls. At this time, you, along with a good broker and trading tool, sell the share and buy it back after some time. This technique gives you a chance to profit from the ‘bear’ market (when the share market is at its low).
Going ‘Long’ and ‘Short.’
Going long means you buy a share or CFD with an aim to sell it at a higher price. In trading terms, going long means making an upward move. On the other hand, going short means a downward move, which is when you sell a share with the aim of purchasing it at a lower price.
Trading long as well as short positions in the market can provide you a good uniformity in CFD trading. When the market is ‘bullish’ (at its high), your long position can profit you well, whereas when the market is ‘bearish,’ your short position comes to profitable use. The consequence is that you get consistent returns, irrespective of market conditions.
Wish to short a stock? Do it by short selling physical shares. This is a simple technique. In short selling, you deal with the share directly. There are other techniques too, but they require you to deal with financial products that are again influenced by the share price. This makes them complex to deal with. You can also sell CFDs over shares.
* In opening a long position, you profit when the share price rises and lose when the share price falls.
* In opening a short position, you profit when the share price falls and lose when the share price rises.
Before entering a short trade in CFD trading, you must know that you sell borrowed shares. You have not acquired their ownership. Your stockbroker holds the proceeds of the trade until you close your trade by buying those shares and returning them. The profit is credited, or the loss is debited from your account.
A large number of stock brokers borrow stocks from big financial institutions that are apt in managing funds and feature a vast and diverse portfolio.
Risks in CFD Trading
When you enter with a short position in the trade, you expose yourself to unlimited risk for loss. This is because, according to theory, the price can rise endlessly, but you can earn a limited maximum profit, which will be in line with your first sale proceeds.
On the other hand, when you enter with a long position in the trade, you enjoy limited risk to the total share cost. Again, as the price can rise endlessly, and so theoretically speaking, you can earn an infinite profit!
What you learn in theory may not always be the case in the real world. However, as you master your CFD trading skills, you would realize that there is a pattern to how the prices rise and fall in the market. Once you catch the tricky pattern of Contracts For Difference, you increase your chances of becoming a millionaire!