If you are a beginner in the world of online trading, you have probably heard many times the term CFDs (Contracts for difference). CFDs are perhaps one of the main reasons why online trading spread worldwide and became popular in recent years. In this article we tell you exactly what they are and why they are the basis of today’s online trading.
What are CFDs?
CFDs are speculative investment vehicles, which acquire their value from a particular underlying asset. There can be shares, cryptocurrencies, index futures, or any other financial asset. The difference is that, when investing with CFDs, you do not acquire the asset as such, you acquire a buy/sell contract, every time you invest in CFDs the investor must buy and sell his contract in a given time frame. This contract is usually concluded between the broker and the Trader.
What does the contract consist of?
As mentioned above, CFDs are short-term speculative investments. Their purpose is to guess in which direction the price of an asset will move. If the investor guesses correctly the direction in which the price will move, the broker will pay the difference between the bid price and the ask price, otherwise if the investor fails the prediction and the price moves against it, the investor must pay the difference to the broker.
Here is an example to understand how it works in practice.
- One share of Amazon costs 25 USD. Therefore, a CFD for one Amazon share will cost 25 USD. Recall that the CFD price is always equal to the price of the adjacent asset.
- An investor decides to buy 10 CFDs on Amazon shares. According to his analysis, the share price will move towards 35 USD.
In this case, his investment would be 250 USD =( 10 # CFDs x 25 purchase price (Bid).
Two scenarios can be derived from this
If the investor is right, and the share price rises to 35, he orders the broker to sell and close the position generating the following profitability.
Initial investment 250 USD
Initial investment 250 USD Result of the transaction: 10 x 35 USD = 350
350 USD- 250 USD = 100 USD.
Earnings 100 USD
If the investor fails his prediction and the share price drops to 22 USD by activating his stop loss (the stop loss is an automatic tool that allows controlling the loss per trade), the result of the trade would be:
Initial investment 250 USD
Result of the transaction: 10 x 22 USD = 220 USD
220 USD- 250 USD = -30 USD
Loses 30 USD
Characteristics of CFDs
The main characteristics of CFDs are that they are contracts without a fixed term (it is the trader who decides when to close the operation, however the longer it takes to close it, the more costs will be assumed for each day that passes). They are also leveraged products, with high margins and high risk of loss. 80% of investors lose money trading CFDs.
It is a loan made by the broker to the Trader so that he can access larger investment amounts and higher profit margins. However, when this figure is used, the risk is multiplied according to the leveraged value. If you are a beginner, we recommend you NOT to use leverage, or to start with a very low degree, otherwise, you will be exposed to losing all your capital and even be owed to the broker.
They can be invested in short or long
Another feature that made them popular worldwide is that you can profit in bull and bear markets. In other words, you can bet that the price of an asset will go down or up. The common thing would be to buy CDFs to sell them more expensive, but Online Trading brokers allow make the operation the other way around.
The trader “sells” CFDs (the broker lends him the contracts) and then buys them cheaper, and earns profits with the price difference.
Remember that when you buy a CFD, you acquire a promise to buy or sell, depending on your bet, you must sell or buy to close a position and receive profits or take a loss.
They are high-risk products, even more so if leverage is used or even more so depending on the volatility of the asset you are going to invest. They are investments that require knowledge, experience, and a solid trading strategy.
High margin in the short term
CFDs are short-term investments (minutes, hours, days, or weeks), and thanks to the volatility of the financial markets investors can generate very high margins in a short period of time. However, the shorter the investment horizon, the more risk you will assume in the operation.
Benefits of CFD trading.
- CFDs allow you to speculate on almost all financial markets and assets: a wide variety of financial assets: indices, stocks, commodities, currencies, futures, energies, metals, etc.
- You can profit in bull and bear markets.
- The vast majority of intra-day strategies are designed for CFD trading. There is a lot of material and information to learn how to properly trade this type of asset.
- CFDs have no expiration and you do not have to change contracts to maintain long-term positions (except for CFDs on commodities and currencies).
- Thanks to the leverage and the new offer of online trading brokers, CFDs are affordable products for any pocket.
Now that you have a little more knowledge about CFDs, this is the ideal time to start trading with a trusted broker, 24 five we are ready to help you achieve your goals, leave us your details by clicking here to start trading online trading easily and effectively.