What is CFD Trading? A Detailed Overview

Many people who are not completely involved in financial derivatives like CFD trading think that speculating the price of a CFD is nothing than gambling which can eventually lead to a financial disaster. So, what is CFD trading? Is it really a gamble? Can it really put you in huge loss? In my opinion, CFD traders or those who use it are the right people to tell you that it is one of the easiest and smartest ways to make good returns. Let’s have a look at the basics of Contract for Difference trading.

What is a CFD?

CFD is an abbreviation of Contract for Difference that refers to an arrangement made in a contract form wherein the difference in settlement is made via cash payments instead of exchanging any physical goods or securities. In general, this is an easy method of settlement since both gains and losses are paid in form of hard money. CFDs offer traders and investors all the advantages and disadvantages of possessing a security without actually holding its ownership. In simple terms, a CFD is a tradable contract between two parties who exchange the price difference in the current value of a financial product, such as a share or index and its value at the time of contract’s closing. The market movements are based upon many factors, such as economic conditions, customer preferences, demand, and supply of the security.

What is CFD Trading? – The Definition

CFDs or Contract for Difference come with an opportunity for traders and investors to make money from speculating price movements without owing the underlying financial product. It is a simple security that is considered by the movements of the product between trade opening and closing, assuming only the price difference without consideration of the product’s underlying value. This is usually done with a contract between two parties (client and broker) and does not involve any index, stock, share or commodity exchange. There are many major advantages of trading CFDs that have significantly increased the popularity of these instruments in the past ten years.

What is CFD trading is clear from its definition provided above though it is very common for many people to associate CFD trading with the term of gambling. Luckily, there are several opportunities to gain higher from this type of trading which can, however, be availed only if you understand the real essence of what is CFD trading all about and how it could be used to succeed.

Is CFD Trading a Gamble?

You may be trading CFDs like a gambler. The fact is that you could trade a CFD by opening a position at excessive levels of leverage. If you are trading your account more than 8 to 10 times larger its size, you are actually putting yourself into a gamble. In simple words, if you have an account with $10,000 and you take total positions of $80,000 or $100,000, you are leveraging too high and risking your capital. Instead, you should take total positions that are not more than 2 to 3 times larger than your account size. This way you not only can trade safely but also keep your trading well within its means. Therefore, it is very important that you not only have a proper idea of what is CFD trading but also know the leaps and bounds of CFD market even before you involve yourself into it.

Below we shall describe how trading CFDs cane be advantageous for traders.

1. Higher Gains with Small Capital – Trading Contact for Difference offers higher leverage than other trading types. Likewise, the standard leverage in the CFD markets goes as low as only two percent of margin requirement and as high as a twenty percent. With lower margin requirements, you do not need to have big capital outlay despite you can gain greater potential returns per trade. You can use small investment to start and if your hunches go correct, you can gain more than what you paid for a deal.
2. Liquidity – The leverage factor in CFD trading promotes liquidity because the assets do not need to be there. Investors who take such risk actually help a small player hedge their stocks. This also help the CFD market grow further by benefiting everyone who is participating inside. As a participant, you are giving your investment for the growth and nourishment of CFD markets and saving weak ones from crashing.
3. No Restriction of Minimum Amount of Capital – No CFD market is bound by requirements of minimum amount of investments or limited trades for day traders. You can open a CFD trading account with for as little amount as $1000 only and start placing trades immediately. Since CFDs reflect corporate actions arising, a CFD owner is entitled to receive cash dividends and take part in stock splits. This helps you increase the number of return on your investments.
4. Holding an Asset without Owning it – CFDs make a perfect example of a speculative product in the market whereby the traders and investors get the benefits of making a contract on financial product movements. To be more specific, these speculations refer to a practice where trader do not buy the actual asset but make an agreement to either pay or get a profit of the difference of the asset today as well as the price at the closing date.
5. No Need to Pay full Amount – CFD trading does not require you to pay the full amount for a position. Instead, you will just pay a fraction of the real share cost by trading on the margin. This way you can afford buying many shares at the same time and enjoy their benefits. If the market goes in your favor, you can reap a great deal of profits. The risk of loss, however, exists there, and if your speculation goes wrong, you are likely to lose your capital too.

Once you are well acquainted with what is CFD trading all about, you need to be sure that you follow a positive expectancy trading system. This means that for every dollar that you risk, you expect to get it back and are able to make a little bit more. Remember, making use of excessive leverage is nothing than gambling hence you need to make sure that you start with small and make your way up slowly and carefully.