An Introduction to CFD Trading and How does it work

CFD Trading

25 Sep 2021

An Introduction to CFD Trading and How does it work

In recent years, CFDs have become the most prominent way for online investors to trade their commodities, currencies, indices, and stocks. Since CFD trading doesn’t involve any assets and operates independently (with market interference), it actually gives greater flexibility than any other methods of trading—like, access to foreign markets, leveraged trading, fractional shares, short selling, and many more.

For those who are not much aware of CFDs, this is the right place for you to gain some insights about it. So, CFD means ‘Contract for Difference,’ which is a legal contract between the investor and the investment bank, or it can be between an investor and the betting firm, usually in the short-term. Close to the end of this settlement, the parties exchange the difference between the opening and closing prices of a specified financial instrument. This financial instrument can be forex, shares, and commodities. Now, Trading CFDs means that you can either make a profit or loss, depending on which direction your chosen asset moves in. Thus, CFD trading is a method of trading in which an individual engages in a contract with a CFD broker (either an investment bank or a betting firm) rather than purchasing the underlying asset directly.

What is CFD trading?

CFD trading is a financially acquired commodity that allows traders to contemplate short-term price changes. The CFD trading can be done on margin, and you can go short (sell) if you think that the prices might go down. You can else go long (buy) if you think that prices will rise. In the UK, CFDs are tax-efficient, which means you don’t have to pay stamp duty for them. Please note, there are different rules in different countries. Many CFD brokers offer products in all the world’s major markets, allowing around-the-clock access. Investors can trade CFDs on a wide range of worldwide markets.

One of the biggest advantages of trading CFDs is that traders may speculate on price movements without the need to physically owning the underlying assets. Traders will usually buy or sell several units depending on whether they think that the price of the financial instrument will increase or decrease.

How does CFD trading work?

In CFD trading, the investor buys or sells several units for a particular financial instrument, depending on the rise and fall of the prices. You don’t have to directly buy or sell the underlying financial asset (e.g. a physical share, currency pair, or commodity).

Companies often offer a wide range of CFDs in global markets, including currency pairs, stock indices, commodities, shares, and treasuries. In CFDs, the higher the price of the instrument moves in your favor, the higher you’ll gain out of each unit of CFDs you have bought or sold. The lower it goes, the more you’ll lose. Let’s learn about the process in-depth:

Firstly, the trader chooses an asset offered as a CFD by the broker. It can be anything like a stock, an index, a currency, or any other asset that the broker has to offer.
The trader then opens the position and sets parameters such as whether it’s a long or short position, leverage, invested amount, and other parameters, depending on the broker.
Both the parties then engage in a contract, agreeing upon the opening price for the position and the additional fees.
The position opens or remains open until the trader decides to close it or it automatically closes as per the command. Such as if it reaches a stop loss point or takes profit or if the contract expires.
Finally, if the position closes in profit, the broker then pays the trader. If the contract closes at a loss, then the broker charges the difference from the investor.

It would be best to understand how to spread bets and CFDs work and whether you can afford to take the high risk of losing your money. All tradings are subject to market risk. However, we always advise our customers to read the market and records before investing their money in CFDs. For more information on trading and other financial investments, connect with us anytime.