If you have been looking to learn about investing in the financial markets, then there is a good chance you have come across the acronym CFD. You may be asking yourself, what is a CFD and how do I trade them? Allow me to break this down for you.
CFD stands for Contract for Difference, and is a common form of derivative trading. CFDs allow investors to speculate on the rising or falling prices of many instruments including Forex pairs, Stocks, Cryptocurrencies, Commodities, Indices, and Bonds. With CFDs you don’t buy or sell the underlying asset or instrument, instead you buy or sell a number of units of the particular instrument, determined by whether you think the prices will rise or fall. For every point the price of your traded instrument moves in your favor, you will gain multiples of the number of CFD units that you have bought or sold. For every point the price moves against you, you will make an equivalent loss.
There are two types of transactions that an investor can make based on their speculation of the future movement of a particular asset. If you believe the instrument in question will move upward in price than you would buy the CFD. If on the other hand, you believe the instrument will move downward in price, then selling the CFD would be the most obvious action.
A CFD is a leveraged product, meaning you can magnify your profits, however, your losses will also be multiplied, as they are based on the full value of the position. The amount of earnings or loss is determined based on the value of the underlying asset when opening and closing a specific position. In other words, the net difference between the purchase price of a CFD and the sale price of the same CFD is calculated, resulting in an overall profit or loss for each transaction.
In conclusion, a Contract For Difference is directly linked to a specific financial asset, and the potential profits or losses coincide with the change in value of the instrument in question. The main difference between trading a physical asset and a CFD is the fact that the ownership of said product is not changing hands when the transaction takes place.