CFD stands for Contract for Difference. CFDs enables traders and investors to speculate on the price movements of various assets without owning them. With over 200+ products such as currencies, metals, commodities and indices, traders are given the chance to profit from the underlying asset price movements.
Don’t miss the chance to trade CFDs with a licensed and award-winning forex broker in South Africa.
If you are looking to trade Commodities or Stock Indices such as gold, oil, the Dow Jones, or FTSE, then CFDs can offer you unique advantages and trading opportunities.
When you trade CFD, you enter a contract with your broker based on the change in price of the underlying asset over time.
For example, Crude oil CFDs track the price of the most current oil Futures. If the oil Futures are currently trading at $50/barrel, the CFD will be traded at a similar price. Therefore, if you buy the CFD when the price of oil is $50 and it rises to $55, you will gain $5 on the CFD, just as if you had bought the actual Futures contract.
But, unlike regular futures, CFDs are available for much smaller purchase sizes and with greater leverage. This makes CFDs an ideal product for investors who are looking to trade in the Commodity and Stock Index markets.
CFDs are bought and sold like any other trading instrument. Therefore, if you believe the price of Crude oil is going to rise then you would buy the Crude Oil CFD and finally, you would then close the position by selling the CFD. Your profit or loss would be the difference in the price of the CFD between the time you entered and closed the position.
Since CFDs are based on Commodity and Stock Index prices, traders use both technical and fundamental analysis to determine whether prices will rise or fall.
For example, if a large storm is expected, which could knock out oil supplies, a trader could buy the Crude oil CFD based on the assumption that a decrease in oil supply will raise the price of oil – if demand remains the same. Also, if a trader believes that stocks have risen too much and are overbought, he/she could sell a Stock Index CFD to profit on any drop in equity prices.
As already mentioned, CFDs are contracts that allow you to trade a variety of underlying markets. For example, you can sign up with a financial broker that specializes in CFDs and be able to trade all the instruments available in your broker’s offering.
Some popular instruments include:
Stocks such as Amazon, Google, and Apple
Commodities such as gold, oil, and coffee
Indices such as Nasdaq, S&P500, and FTSE 100
Cryptocurrencies such as Bitcoin, Ethereum, and Dogecoin
There are unique advantages and disadvantages to CFD trading, as you would expect from any financial investment. However, the main drawback of CFDs is the inherent risk created by the inherent unpredictability of the underlying market and, of course, a somewhat steep learning curve.
As such, while CFDs may be considered to carry a high level of risk, if you can follow simple risk management principles, you can effectively dictate how much you risk losing with each trade.
A variety of the most popular assets under one platform
Nearly all popular financial markets are available to trade through CFDs and you can trade them all via the same trading platform.
Potential to profit regardless of the market’s direction
In a typical investment, ideally, you would like the asset you own to gain value to sell for a profit. However, a CFD allows you to sell the underlying security as well, which means you can profit even if the asset is depreciating.
Low barrier to entry along with no commissions and no hidden fees
Despite all the advantages CFDs hold against traditional investments, you can easily start trading with minimal upfront investment and you only pay your broker a fee based on the market value of the asset you choose to trade.
Leverage, which unlocks higher profit potential
Online CFD trading wouldn’t be so popular or profitable if not for the use of leverage. Leverage, in simple terms, allows a trader to open trades that are worth several times more than his initial investment and enjoy much higher returns.
While the jargon may sound confusing, keep in mind that online CFD trading is merely speculation i.e. you just need to speculate if the price of the asset will climb or drop.
For example, let’s consider that you wish to take advantage of a price hike in gold. You will find this instrument under the XAU/USD symbol in your trading platform, which represents the price of gold against the U.S dollar.
However, regardless of the current price, opening a position on your trading platform, you will be presented with two choices: Buy or Sell.
To put it simply, if you think the price of gold will go up, you should aim to buy (go long) to benefit from the potential appreciation in value. However, even if the prices are crashing, you can still make the same profit by opting to sell (go short).
This is possible because CFDs are financial derivatives and when trading these contracts, you are just speculating on the future price of the asset without actually taking ownership of the asset itself.
It’s important to note here, however, that while you only have two choices (buy or sell), it doesn’t mean that the market will keep moving in the same direction indefinitely.
All financial markets especially the popular ones are incredibly volatile and prices fluctuate every second according to the forces of supply and demand. This is why risk management is such an important aspect of online trading and why traders should keep track of economic news and events that may affect the performance of these assets on the global stage.
In a nutshell, trading can be risky, but as long as you do your research on the underlying market and follow the price charts closely, you will eventually be able to develop a profitable trading strategy.
One of the greatest benefits of CFDs is that they can be traded in small sizes. Also, like forex instruments, large leverage is available for CFD trading. This compares to Futures contracts which are available only in large contract sizes and require a hefty minimum margin requirement per position.
For example – a futures contract on the S&P 500 is based on 50 times the value of the S&P 500 Index. Therefore, if the S&P 500 is trading at $1000, the value of the futures contract is $50,000, and each change of 1 point in the index leads to a $50 gain/loss in a futures position. Also, in order to hold that $50,000 position, you will need an initial margin requirement of $5000 in your account.
With CFDs, CMTrading allows you to trade position sizes of just a small fraction of the total value of the S&P 500. Therefore, the minimum position size in our example would only be $5000 (this compares to $50,000 above). Also, CMTrading has an initial margin requirement of only 2% of the contract size. Therefore, even if a CFD trader took a $50,000 position like in the real Futures contract, the minimum margin would only be $1000.