What are CFDs?

June 13, 2014

What are trade CFDs?

CFD stands for Contracts for Difference. In a lot of ways, CFD trading is similar to purchasing a share – you get the same benefits (and the risks), the major difference being that you don’t actually hold any ownership in the underlying asset. However, with CFDs you do have the potential to profit whether a market goes up or down.

How this works is that you open a Contract for the difference in the price of an asset (like an index, currency, share or commodity), meaning your profit or loss will be the difference between the entry and exit price. For example, let’s say you purchase a CFD in BHP Billiton, expecting it to rise from its current price. If the price movement goes in your favour, you close the trade to receive a profit. If the opposite happens and the price goes against you, you’ll experience a loss. It’s worth noting that even though you’re not purchasing any real shares, your CFD still closely follows the real market movements of the underlying asset.

One of the attractions of CFD trading is the ability to use leverage. With leveraged trades, you only need to invest a fraction of the full amount in order to trade. As well as lowering barriers to entering the market, leverage also allows investors to spread their capital and invest widely rather than tying up large sums in a single investment. For example, if you wanted to purchase $10,000 worth of shares you would need to pay the full amount. However, if you wanted to purchase $10,000 of CFDs in that same asset, because of leverage you’ll only be required to pay a percentage of the total position, leaving you with funds to invest elsewhere.

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When using CFDs and leverage, profits have the potential to be significant relative to the actual deposit. Conversely, a leveraged CFD that goes against you can result in a greater than your initial deposit loss – sometimes a significant one. For this reason, it is very important to note that CFD trading carries a high level of risk and may not be suitable for all traders.

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