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Some Basics Of CFD Trading

Some Basics Of CFD Trading

Generally, people are quite familiar with stocks and Forex trading

, but CFD trading seems to confound many. CFDs, or contracts for a difference as they are also known, are gaining popularity for quite a few convincing reasons. Getting to understand what CFDs are all about can be a great add-on to your trading skill set because if luck is on your side, CFD trading may well become your preferred trading platform.

However, for a newbie, an introduction to basics will help in knowing what contracts for difference are all about.

To make things clear, here is an overview of CFD trading, followed by a brief summary explaining what rewards CFDs can offer in contrast to conventional stock trading.

CFD Trading

CFD trading is flexible trading instruments that allows you to go long and short, leverage your trade, and particularly hedge your trade positions at just a fraction of the cost of the usual stock trading. Precisely, a CFD trade is a binding contract between a buyer and a seller to pay the cost difference between the prices when a stock is bought and when it is sold. Here is what a CFD investor does. A CFD investor speculates on the trade sentiment for the day and then buys or sells a certain quantity of a stock at some point during the CFD trading. Whenever the buyer deems fit, the trade is squared off at a net value that equals the number of shares purchased multiplied by the difference between the opening and closing price. Simply put, if the buyer goes long and the stock closes higher, the buyer will make a profit out of the difference and inversely, the buyer will pay cash to the seller if he or she has gone short.

How Does CFD Trading Compare With Stock Trading?

Frankly, all this depends on the investor's strategy and risk appetite. A contracts-for-difference trader must first decide whether this the right instrument for him or her. A CFD is predominantly suited to those who dig short-term trading and strictly speaking, a comparison will have to take into account many factors. These include paying the cost of stamp duty for stocks versus financing the cost of the CFD.

Advantages

* Trade on margin - CFD trading is primarily on margin. This means you deposit an amount equivalent to only a small percentage of the total value of the trade.

* Liquidity - CFD prices reflect the liquidity of the market.

* Low transaction costs - Brokerages in this instrument are far lower than involved in buying stock from a regular trader.

* Hedging on stock - CFDs allow you to hedge on your stock portfolio by selling short. This way you can take advantage of any short-term decline while keeping your portfolio intact.

Disadvantages

* Over-extending the leverage - Leveraging is a great tool to magnify your profits. However, if you are out of luck or if your strategy falters, the losses will also magnify.

* Trading risks are higher - A short-term CFD trade always carries risks. You may not have to pay the whole value of the stock, but if the market goes the other way, not only will you lose the margin money, but you will also have to shell out additional cash.

In fact, many find CFD trading less of a hassle than even FX trading. Selling one currency to buy another is quite bothersome for many as FX rate fluctuations are difficult to track.

Some Basics Of CFD Trading

By: Commons Yale
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