What traders need to know about CFD trading?

CFD stands for ‘contract for difference’ and CFD trading can be defined as the buying and selling of CFDs. CFDs allow the investors to speculate on financial markets such as stocks, forex, commodities and indices and without having to become the owner of the underlying assets.

However, in the stock market traders should look for the best CFD brokers (https://buyshares.co.uk/cfd-brokers/) as they cannot just start to perform CFD trades on their own.

It is important to note that when we trade a CFD, we are agreeing to exchange the difference in the price value of the asset from the time at when the contract was opened to the time when it is closed.

Probably the biggest advantage of CFD trading is that we can speculate on price movements in any direction, with the profit that we make or the loss that we suffer depending on how correct our predictions are.

What is short and long CFD trading?

As mentioned previously, CFD trading allows us to speculate on price movements of the underlying assets in either direction.

So while we go for traditional trading to make profits as the market rises in value, we could also start a CFD trade that will profit as the underlying market’s value decreases in price. In the world of trading this is referred to as ‘going short’, as opposed to ‘going long’ or buying.

For example, if you think Apple shares are going to fall in price you might want to sell a share CFD on the company. You will still exchange the difference in price between when your CFD trade is opened and when it is closed, but you will earn a profit if the shares drop in price or a loss if the shares increase in price value. Profits and losses will only be seen once the position is closed in both long and short CFD trading.

What is leverage in CFD trading?

CFD trading is leveraged. What this means is that the traders, without having to commit the full cost at the outset, can gain exposure to a large position. For instance, a trader wants to open a position equivalent to 500 Apple shares.

This would require the trader to pay the full cost of the shares upfront if it is a standard trade. However, on the other hand, with a CFD (contract for difference) a trader might only be required to pay 5% of the total cost.

While leverage in CFD trades will allow traders to spread their capital further, it is very important to remember that the profit or loss will still be calculated on the full size of their trades. In the example mentioned above, this would be the difference in price of the 500 Apple shares from the point a trader opens the trade to the point they close it.

What this means is that both profits and losses could go very high, and in some cases traders might lose more than what they can afford to.

Because of these reasons, it is important to make sure that you are trading with enough resources and that you pay attention to the leverage ratio as well.

What is margin in CFD trading?

In the world of trading, leveraged trading with the help of CFDs is often referred to as ‘trading on margin’. This is because the funds that are needed to start a trade, the ‘margin’, represents only a fraction of the complete price.

In CFD trading, there are two types of margin. A deposit margin will be required to start a trade, while a maintenance margin might be required if your trade gets close to incurring losses that the deposit margin, or any other additional funds in your account, cannot cover.

In an unfortunate situation like this, the trader may get a margin call from their provider asking them to add to their funds in the account. If a trader fails to add sufficient funds, the trade may be closed and any losses incurred will be realised.

How to hedge with CFDs?

CFDs can also be used as hedging tools and can help traders profit in a market that is falling. For instance, if a trader thinks that some of the shares in his portfolio are going to suffer a short-term dip in price, he will be able to offset some of the potential loss by going short on the market with the help of a CFD trade.

This is important for the traders to know as any drop in the price of those shares in the trader’s portfolio would be offset by a gain in their CFD trade if they did decide to hedge their risk in this way.