A Guide to trading CFDS

CFD stands for Contracts-for-Difference. CFDs are a form of derivative trading where traders can buy and sell contracts on thousands of assets and benefit from price changes between trade onset and trade expiry without having to take physical ownership of any of the traded assets. 

Therefore, you do not need to be an oil merchant to trade crude oil, neither do you need to be one of the biggest commodity traders in your country to trade CFDs on corn, coffee or copper. You also do not need to have millions of dollars to setup contracts on these assets. This is the beauty of CFDs.

CFDs therefore permit traders to open a contract for the difference on asset prices with the price differential focused on entry price and closing prices. CFDs thus present a versatile alternative to trading the financial markets. Using CFDs, you can trade several different asset classes at the same time from one single account.

Advantages of CFDs

CFD trading confers certain advantages. These are listed as follows:

a) Leverage

CFD trading is leveraged, which provides the trader with the ability to take on much larger positions with a small amount of capital. The capital provided by the trader against such trades is known as the margin. Leverage allows traders to potentially reap the full profits of the leveraged positions if their trades end as planned. Leverage can however cause huge losses if the trades go bad.

b) Bi-directional trading

With CFDs, traders do not profit only when prices go up. Traders have the opportunity to profit from long trades in rising markets, as well as short trades when prices are falling.

c) Trade Thousands of Assets From a Single Account

CFD trading allows the trader to trade thousands of assets across different asset classes all from a single account. There is therefore no need to open accounts with different brokers to trade the various asset classes.

How CFDs Are Traded

CFDs are traded by acquiring a buy or sell position on an asset from the market maker. Trade executions are done in-house by the broker’s dealing desk. Therefore, the broker sets the price at a contract can be bought or sold by the trader. Two prices are set: the bid and ask price. 

A trader who wants to go long on an asset will purchase the contract at the ask price (the price on the right of a quote). A trader who wants to sell an asset will be offered the bid price by the dealer.

Once the trade is initiated, the trader can either follow the trade to the Take Profit/Stop Loss targets set for the trade, or the trader can decide to close the trade manually. At this time, the exit value of the trade is compared with the entry value for the trade, and the difference is credited to the trader’s account (profits) or debited from the account (losses) to provide settlement of the trade. The financial worth of the transaction is decided by knowing how many lots were purchased and the price per lot, as well as the difference between the entry and exit prices.