CFD is a very common trading instrument, but do you know how it really works? Today we will have a closer look on trading with contracts
CFD trading gives you the power to speculate on market price movements without the necessity to buy the physical underlying asset. With this type of trading, it is possible to make money on a growth of an asset as well as on the decline. CFD is a huge market which comprises of a numerous number of assets. These assets are dived into 5 categories – commodities, indices, stocks, ETFs and also forex. In case you want to generate income from a decline of an asset, go with your contract for a short position. In order to earn financial funds when an asset growths, select long position and buy the contract.
What shortage does CFD mean?
CFD stands for “contract for difference”, this type of trading is specified by one important feature. We do not own the asset, but what we own is a contract between ourselves and the CFD broker. That is also the reason why CFD trading is sometimes known as contracts trading.
How trading with a contract for difference works?
CFD is traded with leverage effect so it is not necessary to call up to the whole market value of an asset. That means you can open larger and bigger positions than your funds would otherwise allow you. With leverage trading, you pay just a margin to your broker which provides you with the additional financial means. As a result of that, you can gain profit even from a very small price movements. Experienced traders are capable to really take advantage of this feature, but for inexperienced traders, leverage trading can represent the possibility to lose more money.
Simple example of leverage trading
Every CFD broker offers different financial leverage on different types of underlying assets. For stocks, the leverage is usually 1:20. That means with your 100$ investment you can use the power of 2 000$ of investment. With this „new“ bankroll you can buy for example contract on Tesla shares and you might speculate that their value will grow up. Every single pip that goes in the direction of your trade will mean a great profit for you (because you trade with a leverage). Oppositely you can experience a significant loss if the market goes against you. How much profit you can make or how much you can lose depends on your margin investment and used leverage. Once you evaluate that the trade reached its limit, you can close it and the gains from successful trade will be credited to your account. CFDs don’t have an expiry time thus you are in a full control for how long you will stay in a position.
Where CFD trading takes place
Trading with contracts is possible at CFD providers, so-called CFD brokers. One of such brokers is an international provider of CFD instruments Plus500. Plus500CY LTD is CySEC licenced broker (license no. 250/14) who offers support in 32 languages, very easy to use platform along with a free demo account. But there also many other CFD brokers and their offer is sometimes as much intriguing as the offer of Plus500, but be aware of scam companies which run their business in the CFD world.
How to limit your losses and control your profits
Managing your CFD trades is extremely important. Monitoring every single trade at all times is not in human possibilities (especially if you stay in a position for a longer period of time), that is why we use stop loss and take profit. Their function is clear as a day – to close trades once the price of an asset reaches your predetermined limit. Stop loss will help you with avoiding situations when you would get to insufferable losses. Oppositely, take profit guarantees you that your hard made pips won’t run away and the trade will close itself safely when your profit is sufficient.
How and where can I learn more about CFD?
Trading with a contract for difference isn’t for every investor and using leverage can be dangerous of inexperienced traders. Therefore, I strongly advise you to start on a free CFD demo account. These accounts are usually provided by brokers for free and it would be a great loss not take advantage of them. Once you get the hang of leverage trading on a practise account, you can slowly move to a real account. But never invest money that you can not afford to lose.
What to avoid when trading with contracts
Every trader can make mistakes, but only those traders who are capable of learning from them can move forward with their trading and can eventually top up their game. When you trade CFD you should avoid trading with big leverage, especially if you are not experienced trader. Many traders make the mistake to trade with huge leverage, in the attempt to earn massive amounts of cash. But here is the thing. Even very small price movements with big leverage can cause a colossal hit to your trading from which it might not ever fully recover. So it is crucial to learn, how to handle leverage trading properly, with caution and self-awareness.