We can define CFD trading simply as buying and selling CFDs. CFD stands for contract for difference and CFDs are derivative products since they help you speculate on different financial markets. This includes cryptocurrencies, commodities, indices, Forex, and shares. You do not need to be the owner of the asset in order to participate in online CFDs trading, which is a huge advantage.
Whenever you trade CFDs, you agree to exchange the difference in asset price from when you open the contract to when you close it. This offers the huge benefit of being able to easily speculate on price movements that happen in both directions. You can make money when asset value goes up or when it goes down. The goal is always to correctly forecast.
Short Versus Long CFD Trading
With CFD trading, you speculate price movements. This means that you mimic the traditional trade and you profit from market price going up. Also, you can open a position that profits when the market goes down in price. This second operation is known as going short or selling short. The opposite is known as going long.
As an example, in the event that you believe Bitcoin price will fall, you sell a CFD share of BTC. The difference in price is still exchanged between when you opened the position and when you closed it. However, you do earn a profit when the price drops and you end up with a loss in the event that Bitcoin price goes up.
Long and short CFD trades bring you profits, as long as your forecasts are correct.
The Use Of Leverage
In CFD trading, you can use leverage. This means that you are exposed to a much larger position than what you actually “buy” without having to make a commitment to the full cost. Let’s say that you want to open a CFD position that is equal to 500 BTC. In a standard trade, you have to pay for the full value of 500 BTC. This is done upfront. With the use of the contract for difference, a percentage of the cost is put down, sometimes as low as 5%.
Leverage is oftentimes used by experienced traders because they help spread the investment capital. However, loss or profit is calculated based on the full position size. In the BTC example, this means the difference between 500 BTC price from when the trade was opened to when the trade was closed. Both losses and profits can end up being magnified, with losses easily becoming higher than the initial deposits. Due to this, you need to be really careful about what leverage ratio you use. You need to always trade within the means you have.
What Is Margin?
Oftentimes, leveraged trading is known as being trading on margin. This is because funds needed to open or/and maintain positions represent just a fraction of the entire trade size. These funds required are known as margin.
As you trade CFDs, 2 margin types exist:
- Deposit Margin – You need this to open the position.
- Maintenance Margin – Might be necessary when trades get really close to incurring a loss that would not be covered by deposit margins.
When the maintenance margin is close, the provider might call the trader. The goal is to ask to have the account topped up. When enough sufficient funds are not added, the position might be closed and huge losses would appear.
Last but not least, CFD training can be utilized to hedge against portfolio losses. As an example, if you think that some shares inside your portfolio can be affected by a value dip in the short-term, a part of the loss might be offset by simply going short through the CFD trade. When you hedge risks with the use of CFDs, a value drop inside the portfolio is offset by the gain that is made through the short online CFD trade.
Disclaimer: This content does not necessarily represent the views of IWB.