How To Hedge Using Cfd Trading

Before we get to how best to use CFD trading for hedging

, it is important to understand the meaning of all the terms involved. A CFD is short for 'contracts for difference' which is a contract between the 'buyer' and 'seller' that requires the seller to pay the difference between asset value at the current time minus that at contract time.

Of course, depending on whether the value comes to negative or positive, it could be the buyer paying the seller, or vice versa. Simply put, trading CFDs allows speculation on the financial instruments that they represent without actually having to own them. It is important to know that each CFD can have its own contract terms depending on the CFD provider and the trader. But the one thing common to all CFD trading is the need to fix the price of a volatile commodity by both buyer and seller.

Let's also understand 'hedging' more closely. Financially speaking, hedging is about covering risk. It is about buying instruments in one market to offset the exposure to risky price fluctuations in another. An insurance policy is the simplest kind of hedging technique. Another very common hedge instrument is a futures contract. For example, let's consider a farmer whose profit is always subject to the wheat demand at the end of the harvest cycle. It could be high or low, and likewise is the farmer's profit. In creating a wheat futures contract at a specified price, the farmer insures himself from having to sell it lower. But he also gives up the right to sell it higher and that provides a benefit to the buyer. Who actually makes a profit will depend on future conditions, but both parties have benefited by mitigating their risk on what is a perceived to be a volatile commodity.

How Can CFD Trading Be Used For Hedging?

The value of shares and other financial instruments is constantly at risk. Investors often are confused as to what is the best time to cash in. They want to wait but are scared about the share prices dropping. They can solve this dilemma by CFD trading. For example: If they want to not risk the price of their shares falling, then they take a CFD in a short position. If the share price moves up, then they cover the difference. Yet if it moves down, then they get the differential back""no profit, no loss. Meaning that they are for 'hedged' against all volatility in that particular shareholding. The simple idea is to enter an equal and opposite CFD position to the current shares, which neutralizes you to all movement in prices. Some other less known benefits includes:

* Buyers can earn interest on short CFD positions.

* There is no fixed expiration date on CFDs.

* There is no minimum strike price or parcel price; meaning that a buyer or seller decides what they are comfortable with.

In summary, CFD trading is a great way to protect your portfolio against losses.

by: Leslie West

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