The financial markets continue to evolve, and one of the trading strategies that keeps drawing both newcomers and experienced investors is CFD trading. The reason behind the popularity of CFDs (Contracts for Difference) is that they enable one to place a bet on a market without necessarily owning the underlying assets.
CFDs provide an opportunity to make potential profits regardless of whether the market is increasing or decreasing in prices, in forex and commodities, and in indices, shares, and even in treasuries. If you’re just starting out, here is a simple guide to help you understand CFD trading.
Understanding CFD trading
It is important to understand what is CFD trading in order to get started. In this type of trading, you are not actually buying the asset, such as a stock or a commodity. But you are just promising to buy or sell the difference between the price of the same when you initiate the trade and when you close it.
That is why CFDs are so versatile; instead of conventional investing, where you only tend to make a gain once the price increases.
How Does CFD Trading Work?
Here’s a simplified step-by-step of how CFDs function:
- Select a market: Select between shares and currencies, commodities, or indices.
- Choose direction: In case you believe the price will increase, you should purchase it, and in case you believe it will decrease, then sell.
- Select your position size: The size of trading you do will define the amount to gain or lose with each price change.
- Close the position: The profit or loss is realized upon closing the trade.
It is worth noticing that profit may be appealing, but losses also may occur easily–particularly when leverage is high.
The Role of Leverage and Margin
One of the defining features of CFDs is leverage. This means you just have to deposit a small percentage instead of paying the full value of the trade upfront. It is called trading on margin.
Going Long vs. Going Short
CFD trading offers two options:
Going Long (Buy): You open a trade if you expect the price to rise.
Going Short (Sell): You open a trade if you believe the price will fall.
This flexibility allows traders to potentially profit in both bull and bear markets, which is something traditional investing doesn’t always allow.
Costs Involved in CFD Trading
Like any financial product, CFD trading isn’t free. Here are the main costs to keep in mind:
- Spreads: This is the variation between the sell and purchase price. When the spread is narrower, you are able to access potential profits in a shorter period.
- Holding Costs: When your trades are left open overnight, you might pay (or even receive) a little fee, depending on the position.
- Market Data Fees: This is needed to access share CFD prices in real-time.
- Commissions: Applied to share CFDs, in particular, but many brokers provide commission-free trading of US and Canadian stocks.
Being aware of these costs also allows you to plan trades better.