What is CFD? Explained with Examples
What is CFD trading:
With CFD trading, you don’t buy or sell the underlying asset (for example a physical share, currency pair or commodity). You buy or sell a number of units for a particular instrument depending on whether you think prices will go up or down. We offer CFDs on a wide range of global markets and our CFD instruments include shares, treasuries, currency pairs, commodities and stock indices such as the UK 100, which aggregates the price movements of all the stocks listed on the FTSE 100.
The contract for differences (CFDs) are contracts that are tradable between clients and a broker.
While these contracts may be accustomed speculate on the exchange markets, they’ll even be accustomed back assets like precious metals and oil, additionally to market factors like indices
CFDs or contracts for difference is a financial instrument that allows a trader to participate in various markets that aren’t normally as flexible as the Forex market but allows them to replicate that kind of leverage and granularity.
While trading on margin allows you to magnify your returns, your losses will also be magnified as they are based on the full value of the CFD position.
Both Forex and CFDs are helpful for the purpose of speculation.
CFDs are contracts between traders and brokers in which they comply with exchange the distinction between the access and exit price of an underlying asset. Even as those contacts may be used to invest in the forex markets, they also can be used to wager on belongings like precious metals and oil, similarly to marketplace elements including indices.
CFD is basically an agreement between two parties to pay the difference in the underlying asset’s price from its current value and its value at the time the trade is closed.
What sets CFDs apart from forex is that the former spans more financial markets, such as commodities and equities, which allows a trader to diversify his positions. You can speculate on global stock indices such as the S&P 500 or FTSE and trade the price of soybean against the U.S. dollar. More possibilities, more profit opportunities!
While forex trading is mostly driven by fundamental and technical factors, CFD price movements are generally influenced by supply and demand specific to the asset being traded. For example, price fluctuations for several commodities can be subject to seasonal factors while stock price trends may be dictated by earnings reports.
Make sure you also read up on how transaction costs are computed, as some asset classes are subject to commission fees while others aren’t. CFDs are also typically subject to a daily financing charge if you plan to keep trades open overnight. Margin requirements also vary among brokers so make sure you’ve required margin.
The CFD doesn’t really place orders in the numerous markets for you; relatively it places a trade on a particular price in one direction or another. Generally, this is done by using a broker and you are rewarded via the difference in price from when you enter. (Just like the futures markets.)
CFD Currencies Australian Dollar, Swiss Franc, Euro Dollar, British Pound…
CFD Shares Apple, eBay, Microsoft, Facebook…
CFD Indices Dow Jones, Germany 30, Japan 225, Mini Nasdaq, Mini S&P 500, UK 100…
CFD Energies UK Crude, US Crude, Natural Gas, Heating Oil…
CFD Commodities Sugar, Soybean, Wheat, Coffee, Corn…
CFD Treasuries German Bond Futures, 2 YR/ 5YR/ 10 YR US Treasury…
CFD Metals Gold, Silver…
Example of a CFD trade (The Price is pence like 98 pence, 100 pence, 110 pence etc)
Buying a company share in a rising market (going long)
In this example, UK Company ABC is trading at 98 / 100 (where 98pence is the selling price and 100pence is the buy price). The spread is 2.
You think the company’s price is going to go up so you decide to open a long position by buying 10,000 CFDs, or ‘units’ at 100 pence. A separate commission charge of £10 would be applied when you open the trade, as 0.10% of the trade size is £10 (10,000 units x 100p = £10,000 x 0.10%).
Company ABC has a margin rate of 3%, which means you only have to deposit 3% of the total value of the trade as position margin. Therefore, in this example your position margin will be £300 (10,000 units x 100p = £10,000 x 3%).
Remember that if the price moves against you, it’s possible to lose more than your margin of £300, as losses will be based on the full value of the position.
Outcome A: a profitable trade
Let’s assume your prediction was correct and the price rises over the next week to 110 / 112. You decide to close your buy trade by selling at 110 pence (the current sale price). Remember, the commission is charged when you exit a trade too, so a charge of £11 would be applied when you close the trade, as 0.10% of the trade size is £11 (10,000 units x 110p = £11,000 x 0.10%).
The price has moved 10 pence in your favor, from 100 pence (the initial buy price or opening price) to 110 pence (the current sale price or closing price). Multiply this by the number of units you bought (10,000) to calculate your profit of £1000, then subtract the total commission charge (£10 at entry + £11 at exit = £21) which results in a total profit of £979.
Stop out, Margin, Leverage
Losses are taken not from the leverage money directly, but from the trader’s capital. If losses get to a certain point where the trader’s equity is almost wiped out, the broker will then automatically close the position, to secure the leverage money they provided earlier.