‘Contract For Difference’ mostly called CFDs is known to be a popular and innovative investment tool which allows you to trade on the price movement of any financial market like stocks, commodities, indices and forex without actually owning the underlying instrument.
If you think the price of an underlying asset will go up you can buy a CFD and benefit from that rise, this is called going long.
If you think the price of an underlying asset will go down you can sell a CFD and profit from that fall, this is called going short.
The profit or loss you make is the difference between the price when you entered your position and the price when you close it. The more the market moves in the anticipated direction, the more profit you make. But the position can also move against you resulting in a potential loss, when you buy a CFD you don’t have to pay the full value of the position instead you reserve some fraction of it, also known as margin, this practice is called trading on margin.
For example, let’s say stock ABC is trading at 10 USD, you think the company’s price is about to go up so you buy 1 lot of ABC (One standard lot consists of 1000 CFDs).
Company ABC has a margin rate of 10% which means you only need to have 10% of the total value of trade as position margin.
Here is the math below to help you understand the concept a bit better,
1000 CFDs x $10 = $10,000
And 10% of $10,000 = $1000 (Position Margin)
Now lets say your prediction turns out to be correct and stock ABC is trading at $15,
So 1000 CFDs x $15 = $15,000
So you made a profit of $15,000 — $10,000 = $5,000, while only investing $1,000.
3 Reasons Why You Should Trade CFDs:
- You can profit in both rising and falling markets
- Due to the leverage effect, you can use your capital very efficiently
- The transaction cost is very low
However, keep in mind that just like you can experience a high percentage return with CFDs you can also experience higher percentage losses if the stock goes down.
We, at Deriv.com hope you will find this article useful.
We invite you to try CFD trading with a free demo account, without any risk at all!