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CFD Trading Explained

CFD Trading Explained

CFD Trading Explained
CFD Trading Explained

Contracts for Difference (or “CFDs”) offer traders an easy way to trade a wide variety of assets in a diverse set of financial markets. Gains can be achieved in both rising and falling market climates and this is as simple as buying an asset when you expect its price to rise in the future, or sell it of you expect its price to fall at a later date.

CFD Trading Example

To get an idea of how CFDs commonly trade, let’s look at an example using a Microsoft CFD, which will be a contract with no expiry date that will match the exact price activity of the underlying share price. The difference with traditional share trading, however, is that you will not actually own shares of Microsoft and you will not be required to deposit the full amount of your buy or sell position. Instead, you will be trading a “derivative” instrument, which will mirror the characteristic of the price changes seen in other commonly owned shares of Microsoft.
To open your position, let’s assume we expect the price of Microsoft to rise. Our CFD broker offers us two prices: $25.00 and $25.50. The first price is the sell price (which is what we would pay if we expect Microsoft stock to fall). The second price is the buy price, which is what we will pay because we expect Microsoft stock to rise.

Margin Trading

Using our example, we now need to figure out how much the trade will cost. When trading CFDs, margin trading can be utilized, which allows us to pay only a percentage of the total position size. If our broker requires a 5% deposit for all margin trades, we will only need to deposit 5% of our total position size. In addition to this, a small commission will be added (usually in the range of 0.05%-0.10%).
These commission charges will be seen for each transaction. Since CFDs based on share prices have no expiry date, these positions can be closed at any time, which offers an added level of flexibility over other types of trading contracts. Using out example, our trading account will be credited with gains (for the full position, not just 5%) as long as Microsoft stock rises in value. Our trading account will be debited if Microsoft decreases in value (also for the full amount of the contract size). Interest rates and dividend payouts will also effect the total gains or losses accrued during the life of the position.

CFD Trading Markets

One of the biggest advantages of CFD trading is the wide range of asset classes that are currently made available to traders. Some of the most popular choices include Forex, stock shares, stock indices, and commodities, among others. All of these markets will involve some different characteristics. For example, commodities like gold and oil will actually have set expiry dates (which means that the position will be closed at a predetermined date). There is still flexibility in these markets, however, because the positions can be closed at any time before the expiry date.
In addition to this, different markets will also involve different trading costs, as some markets are easier for individual investors to access than others. For example, commission charges will only be added for trades that are based on stock share prices (there is no commission in the other markets).
In essence, CFDs are made available so that investors can speculate on the future prices of a wide collection of asset classes. These trading instruments are becoming more and more popular as investors continue to move from the trading floor to computer based trading and the growing number of CFD providers are always trying to lower their trading costs to improve the profit and loss possibilities for new and experienced traders alike.

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About Darth Trader

When I left you I was but the learner. Now I am the trading master.

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4 comments

  1. Clear analysis of the various aspect of the CFD trading experience, excellent review.

  2. 5 star article brilliant. I am new to blogging and you used a langauge I can understand

  3. Thanks for sharing, this is a fantastic blog.Thanks Again.

  4. CFD trading has a wide range of asset classes that makes trading more flexible especially in forex which is my line of trading.