There are many retail traders on the forex market looking to make a profit. Many markets have setbacks such as large startup capital. Contracts for difference allow traders to trade without the need to own the actual assets.
CFDs are contracts between a buyer and a seller. These contracts are usually short term. When the contract comes to an end, the difference between the opening and closing prices are shared.
Traders can predict prices going up or down. If their predictions are accurate, they could earn a profit and if not then they will incur losses.
What Is CFD Trading?
Contracts for difference (CFDs) are a unique form of trading. A trader can speculate on a market without the requirement of owning a share of any of the underlying assets. Some of the financial markets on which traders can trade CFDs include; forex, indices, shares and commodities. In essence, CFDs are derivative products.
A trader agrees to exchange the difference in asset prices from the opening and closing point of the contract. Usually, these contracts are short term.
A major benefit of CFDs is that traders can benefit from both profits and losses. Prediction of price movements can be done in either direction. This means that traders can forecast a profit or a loss. They earn depending on how close their prediction was.
With CFDs, traders can trade on margin. There are two options:
- Going short – this is when traders decide to sell shares when they think prices will go down
- Going long – this is when traders decide to buy shares when they think prices will go up.
Regardless of the direction, the trader predicts price movements will go, a close forecast will be profitable to the trader.
How Does CFD Trading Work?
The essence of CFD trading is that investors may make a profit off-price movements without owning any underlying shares.
A CFD is set in motion when a client and broker open a contract through a buy or sell order. Such contracts are opened through various trading terminals.
There are two things any trader must understand before opening a contract.
- Buy order – This means that the trader is predicting that the prices will move upwards to earn a profit from the difference. It also means that if prices decrease, the trader bears the losses.
- Sell Order – This means that traders predict that prices will move downwards to earn them a profit. However, if the prices increase, they will incur losses.
Other than the two key points to opening a contract, traders should understand the respective regulations and specifications on their trading platforms.
Costs Of CFD Trading
There are some key things to note when it comes to CFD trading. We look at a few key concepts related to the costs of CFD trading.
Two prices may be quoted for a CFD.
- Sell price – It is also known as the bidding price. This is the price at which a short CFD may be opened.
- Buy price – It is also known as the offer price. This is the price at which a long CFD may be opened.
A bidding price is usually a little lower than the current market price while the offer price is slightly higher.
A trader must pay the spread when trading CFDs. Spread is the difference between the bidding price and the offer. A narrow spread means that a trader can begin earning a profit faster. However, if the prices move against the predictions made, traders make losses quite quickly on a narrow spread.
- Holding Costs
Open trades may incur a certain cost when the trading day is spent. The direction of a trader’s spread will determine whether those charges are negative or positive.
- Commission Charges
These are costs exclusively incurred by traders who trade CFD shares.
- Market Data Fees
CFD trading services are offered on specific trading platforms. These services will cost some money. They are also known as broker related costs.
CFDs are a unique form of trading that can be very beneficial to traders. It has startup requirements that are quite low. This allows even retail traders to trade. It is most useful to those who are trading short term. Like other forms of trade, it has its benefits.