CFD means Contract for Difference. Unlike other trading options, CFD is a derivate product that gives traders a chance to theorize or hypothesize various financial markets such as indices, commodities, and forex. The highlight of this trading option is that you do not have to own the assets.
Instead, for every CFD, you agree to exchange the difference in the price of the selected asset from the point the contract starts to when it closes. You can predict the price will either increase or decrease and the amount of gain or loss is dependent on your forecast or prediction degree of accuracy.
As mentioned earlier, CFD trading allows traders to predict the price shifts of an asset in either direction. Like the traditional trade, where you earn if the market price of the traded asset increases, you can enter into a CFD contract to profit if the market price of the asset drops. This ingenious strategy is referred to as "going short." It is the direct opposite of "going long."
For example, if you foresee a fall in the price of Apple shares, you can decide to sell a share CFD before the prices start to drop. Concisely, you will profit if the shares drop as you predicted and a loss if the price goes the other way.
A profit or loss is only recorded in both short and long trades when the position is closed.
You can take full advantage of the profit-generating opportunities that CFD trading offers without investing the full amount at the start of the trade. For instance, you set the open opposition equivalent to 1000 Apple shares. If you opt for the conventional trade, you would be required to pay the total cost of the 1000 shares upfront.
Luckily, with a contract for difference (CFD), you might only be required to pay 10% or 5% of the total cost of the shares. Even though this form of trading allows you to diversify and invest more without spending a fortune up front, remember the loss and profit will be calculated on the full scale of the set start and closing position.
Based on this fact, it is of paramount importance to leverage the ratio and invest an amount within your budget. Do not invest an amount that will plunge you into financial turmoil if the tide changes.
Leveraged trading, also referred to as trading on a margin, means that the funds you need to open and maintain the speculated position, the margin, is only a fraction of its total size.
There are two primary trade margins you should keep in mind when CFD trading.
To open a position or price position of the trded asset, you need a deposit margin.
A maintenance margin is required if the set trade is almost incurring losses that the deposit margin or the amount of money in your trading account cannot suffice. In this kind of scenario, the provider will either call or send you an email requesting you deposit more funds in your account.
Firstly, CFDs can be used to prevent an imminent loss in an existing trade.
For example, if you think the price of Tesla shares in your portfolio will drop soon, resulting in a loss, you can reduce the potential loss by placing a CFD trade to short the market.
Now that you clearly understand what CFD trading entails, let us shift gears and look at four gold-worthy concepts to help you get maximum profit from every CFD trade.
CFD trade has two prices; the buy and sell price
The selling price, which is also referred to as the bid price, is the price you can use to enter a short contract of difference trade.
The buying price or the offer price is the price that you commit or deposit in your account when you open a long contract of difference trade.
The set sell price is always lower than the current market price. On the other hand, the buy price is slightly higher than the market price. The difference between the buy and sell price is the spread.
In most instances, the spread covers the cost of opening a CFD position on a traded asset such as gold, silver, or even crude oil. That is, the sell and buy prices are adjusted to match the cost of the trade.
The first thing to pay attention to is that all CFDs are traded through standardized contracts. The asset you intend to trade on determines the size of the contract.
For example, silver is traded in many commodity exchanges in specific lots of 5,000 troy ounces. The same CFD has a value of 5,000 troy ounces.
On the other, if you have shares of a particular company and enter in a CFD trade, the contract size is equivalent to one share of the company.
Unlike other trading options, a contract for difference trade does not have a specific or fixed expiry period. A trade position is marked as closed if you place another trade in the opposite direction to the initial one. For example, if the buy position is 1,000 gold contracts, it will be closed when you sell 1,000 gold contracts.
You should also note that if you keep the CFD position open past the stipulated cut-off or trading stop time, an overnight funding charge will be imposed. The cut-off time varies in international markets, so consult your broker to cushion yourself from this charge.
The loss of profit from a contract for difference CFD trade is calculated by simply multiplying the total number of contracts or the expressed per point of movement (set value of each contract). Then, multiply the total with the difference in closing and opening price.
Profit or loss = (no. of contracts x value of each contact) x (contract closing price – contract opening price)
To know the net profit or loss, deduct the fees or charges paid to the provider, such as guaranteed stop fees, commission, or overnight funding charges.
Contract for Difference (CFDs) allows traders to profit from each trade by correctly predicting a drop or increase in the price of the traded asset. Like any other investment, make sure that you only commit an amount you can afford to lose in case the trades do not go your way. Good Luck!