‘What Is A CFD’ Explained
If you have been considering ways to make money from trading, then you have likely examined several different forms of trading. For example, you might be wondering what is CFD trading, binary options trading, and so on. In this article, we will examine CFD trading in detail. You will learn exactly what this kind of trading is, why it is popular, and how people fit CFD trading into their portfolio.
I Think I Understand, But What Is CFD Trading?
CFD stands for “Contract For Difference.” A CFD is a financial instrument that pays off based on the difference in price for some underlying asset over a certain period of time. These contracts can take two different forms: a buy position and a sell position. If you open a buy position through a CFD, then you make money when the asset goes up in price, and for a sell position, you make money when the asset declines in price. CFDs do not require you to actually own the asset in questions: you are just buying a contract that is related to the asset’s price. These CFDs have a few important parts: a time horizon, a direction, an asset, and a payout structure.
I Prefer Forex, Why Should I Care About CFDs?
There are a few reasons that you should care about what is a CFD. First of all, this is a form of trading that gives you access to markets that would otherwise be totally out of reach, especially in commodities. Holding a CFD does not mean that you own the asset, so it’s much easier to trade and open positions. You deal with a secondary market of financial contracts instead: the actual asset never passes into your possession, so all the logistics and complexity of asset ownership do not come into play. Next, CFD trading is extremely useful for hedging because it is based directly on asset prices. If you are worried that your portfolio is susceptible to some kind of risk that you can boil down to one asset price, you can cover your risk with the right CFD. Lastly, CFDs are very low-margin, so you can open and move a lot of positions without needing to put down as much money as you would if you were in a different market.
Wide Variety of Assets To Choose From
Because you do not need to own the asset, you can get into a huge diversity in assets. For example, you can trade with the market as a whole by using a stock market index as your asset. You can trade the bonds of foreign governments without needing to deal with converting currency. Speaking of currency, you can open CFDs against currency pairs as well. These are all markets that are hard to access directly, but you can add them all to your portfolio easily due to the simplicity of the contract. Diversification is the key to a strong portfolio, and CFDs open up the possibility of a much wider selection than you might otherwise have. That tangible advantage is enough to make CFDs worth considering on their own.
Types of CFDs
The choice of CFD options or derivative products is quite diverse. Options available to you include
- Share or Stock CFDs – Trading shares on global stock exchanges such as ASX (Australia), NYE (New York) or LSE (London Stock Exchange) is actually the most common method to trade CFDs. Buying stocks means you are buying or investing part ownership in a company for which you can later sell your share for a profit or loss depending on price moves.
- Index or Indices CFDs – This is when you bank on the performance of an index in the financial market. This means you are betting on the performance of a market or group of assets in a Market. Types of indices include Dow Jones, NASDAQ, ASX, LSE, Nikkei.
- Commodieis – This is when you invest in physical assets. There are two type of commodities. These are hard commodities and soft commodities.
- Hard Commodities are assets that are mined. Typical examples of these are Precious metals such as Gold, Silver, Copper and energy resources such as Gasoline (Crude, Oil)
- Soft Commodities are assets that are gown – classic example include Beef, Coffee, Sugar, Soy Beans, Peanuts, Corn and Wheat.
- Cryptocurrencies – A more recent type of CFD. Cryptocurrencies are digital assets used for secure and safe financial transactions. No one know if cryptocurrencies will actually take off as a proven mode for making transactions but Bitcoin looks to be the most likely to prove successful Other competitors include Blockchain, Ethereum and Litecoin. Dues to the uncertainty of this trading medium there is a high risk you could lose money. On the flip side, potential profit can be significant as the mass market are yet to use this medium for trading.
- Treasury – This is when you trade that treasury notes such as US Bonds will increase in value.
There are two types of CFD traders. These are day traders and investors. Day traders are focused on the short term share prices or cfd prices when cfd trading. Investors on the other hand are long term traders so are not concerned with micro price movement. They might check the closing prices of assets they own in the global markets on an occasional basis.
A Useful Hedging Tool
The ability to hedge on currency prices and other important elements in the world economy can make a big difference to the robustness of your portfolio. You need to be able to withstand big shocks that will disrupt your assets, but if you can predict that disruption and preemptively negate it with a hedge, you remain safe. With a CFD, you can open a quick position on any asset and timeframe to make sure you are covered. Wondering what is CFD trading is not a productive question because different investors use it in different ways. However, it is fair to say that hedging is one of the most important of those ways.
The CFD market is a particularly cheap one. You can open a large position with a small stake thanks to the low margins. That makes it cheap to hedge, for example. If you are trading CFDs for profit, then you can get a larger upside for the same cost as a different investment. Remember that with short selling, there is unlimited downside. If you open a buy position but it does not go your way, you only lose your stake. But sometimes a sell position is the only thing that works for your hedge, or you have a strong feeling about it. The low margins mean you can purchase many units of a contract, and that helps you get more for your money.
‘What Is A CFD’ Finally Explained
In summary, if you were not sure about what is a CFD, then hopefully this article gave you the basic concepts. There are many CFD brokers online that can help you set up trades, provide you with detailed advice, and facilitate the process of trading. Be warned that many of them tack on their own fees, so you need to do your research and ensure that you are getting a good deal. Once you have a broker you like, you can do anything you want with CFDs. They are one of the most flexible financial instruments available to the common investor. Be sure to do a deep dive to learn more about what is a CFD, how you can trade this instrument and how to apply it to your personal situation. Be sure to contact an investment professional before you commence trading CFDs, especially if this is not your first time trading derivatives. The trading of highly leveraged financial products that can cause large losses so don’t bite off more than you can chew.