CFD trading or contract for difference is derivative from other financial instruments such as stocks, bonds, and stock index values.
The contract is an agreement between two parties to pay the difference between the selling price and the buying price.
When the contract value rises, the seller will pay it to the buyer and will apply the opposite when the contract value drops.
Basically, CFD Trading offers trading products and services that allow you to trade the market through brokers for assets without having the asset instruments that are in the contract.
For example, if you take a “buy” CFD Trading action on an oil commodity, then you don’t really buy oil.
CFD allows traders to get profit from the increase or decrease in the price of a financial asset underlying the contract.
Both assets in the form of stocks, commodities, and currencies.
In addition, CFD trading is available with high leverage options.
So the capital needed to start CFD trading can be much lower than if a trader wants to trade his original financial assets.
Trading CFDs includes very high-risk financial market trading activities that should only be done by experienced traders. If you are a beginner, it would be better if you try trading original financial assets only.
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How does CFD trading work?
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Actually, the way CFD Trading works is almost similar to investment activities in other financial markets.
For example on stock CFDs, you decide to invest in company A shares by buying 100 shares at a price of USD25.26. The total cost to be incurred is USD 2,526.
But in CFD Trading, you can trade on margin, so you don’t have to spend that much money. For example, your broker offers to trade with a margin of 5 percent,
You can buy these shares with only USD126.30.
When after a few hours later the purchase price of this stock rises to the price level of USD25.76, shares can be sold for a profit of USD50.
However, the bid CFD price can only be 25.74 because the spread size on CFDs is usually greater than the actual stock market (the spread here is the profit of the broker who brokers the CFD Trading).
So there can be a difference of several cents in profit.
Therefore, the profit from CFD Trading shares may only be between USD46 and USD48 only. In this case.
It is known that spreads on CFD Trading limit trader’s profits.
CFD Trading Features.
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CFD trading has several advantages with existing features.
Traders who trade CFDs do not have to submit funds with the exact amount of the price of the assets being traded.
This is because a CFD broker provides a leverage feature that allows traders to transact only by giving a certain amount of collateral deposit.
The collateral for CFD trading is generally determined as follows:
- For Stock CFDs, traders must provide a guarantee of 10% of open positions (number of lots x 100 shares x opening price). Thus, leverage for shares is 1:10. However, because the leverage is relatively low, this instrument is less attractive for speculation, stocks usually have a significantly larger range of asset price movements compared to forex.
- Commodity and Index CFDs from futures exchanges, collateral is determined individually for each contract. Its value is usually related to contract specifications.
Thus, the amount of collateral and leverage in CFD trading activities is set individually for each contract and does not apply almost universally as in forex trading or ordinary stock trading.
Time Transaction Feature.
CFD trading activities include over-the-counter trading.
But the timing of CFD trading must be in accordance with the specifications of the underlying financial asset contract.
For example, for CFDs on individual stocks from US exchanges, the transaction time is 16: 30-23: 00 (GMT + 2).
Whereas for commodity CFDs, the transaction time is determined individually.
Based on the opening hours of the exchange where the commodity is traded.
CFDs include futures. That is, all contracts are only transacted for a certain period of time, for example, one trading day.
After the period expires, the transaction must be closed manually or will be closed automatically. The following day, the transaction can be reopened for the next contract of the instrument.
Trading Spread and Commission Features.
Trading spreads and commissions are aspects that are calculated by traders because they include transaction costs.
In trading, any CFD instruments, floating spread rules are applied.
That is, the difference between the bid / ask price at the opening and closing of the transaction will change over time.
As for trading commissions, each broker can set different amounts depending on the type of CFD. As an example:
- For Stock CFDs, the commission is 0.12% of the contract. So, commission = number of lots * opening price * 0.12%
- For Commodity CFDs, a flat commission of USD13 per lot.
Even though rates vary, all CFD trading commissions are only charged once, which is when the trader opens a transaction.
Advantages of CFD Trading.
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CFD trading offer advantage for a trader.
Trading with Margins
CFD Trading provides much higher margin facilities than on the stock market or real commodity futures markets.
On CFD market has minimum margin requirement starting at two percent. The margin requirements depend on the assets being traded, for example on stock CFDs, margin requirements can be up to 20 percent.
Lower margin requirements make capital needed by traders or investors diminish, so the potential to get more profit. However, it should also be remembered that trading on margin presents a higher risk as well.
Global Market Access From One Platform.
Most CFD Trading brokers offer a variety of products that are traded on major markets in the world, including those from the United States, Britain, Europe, and others.
This shows that traders can easily trade in many markets using only one platform.
In addition, the CFD market generally does not have certain rules related to selling, because an instrument can be sold and purchased a.t any time.
Professional Order Execution without Additional Fees.
CFD brokers offer many types of orders such as ordinary brokers, namely, stop orders, limit orders and one-cancels-the-Other (OCO) orders.
In addition, most brokers do not charge commissions or other fees when traders enter or exit the market.
Brokers take advantage of spreads, namely the difference between the selling price (bid) and buy (ask). Spreads can be small and large, large depending on the current market price volatility.
Disadvantages and risks in CFD trading.
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Even though it looks very attractive, CFD Trading still has some disadvantages. The existence of spreads on entry and exit may reduce potential profits due to the thinning difference in price movements. In addition, there are also several risks inherent in CFD Trading.
Risk of Market.
The main risk in CFD Trading is a market risk because contracts on CFDs are designed to pay the difference between the opening price and the closing price of a particular asset.
CFDs are traded on margin, allowing traders to use small capital in taking risky positions.
The existence of a margin or high leverage facility is very dangerous and has a high potential to cause traders to lose more than their capital if market movements are not in line with predictions.
One way to reduce this risk is to use stop loss and apply money management.
A broker is a company that provides assets in financial transactions.
When buying and selling CFDs, the only asset being traded in the contract issued by the broker.
Therefore, make sure to choose the right broker, which has clear regulatory status and not deception.
Example of trading CFD.
1. Trading Stock CFDs.
For example, you expect the Coca-Cola Company’s shares to rise. The purchase price is currently USD61.20, while the sales price is USD61.19. Then you buy 300 shares (3 lots) at the price of USD61.20.
If two hours later, the price rises to USD61.57 for the purchase price and USD61.56 for the sale price, then you decide to sell it at a price of USD61.56, then you will benefit. How much is it?
Earnings per share are 36 cents (USD61.56 – USD1.20), or 300 shares will receive a profit of USD108.
2. Trading CFDs for Crude Oil Commodities.
For example, you estimate the price of Crude Oil will fall.
The CFD price for commodity futures in the form of Light Sweet type crude oil with delivery in December 2010 was USD81.43 for purchases and USD81.42 for sales.
You decide to sell 0.5 contracts at the current price of USD81.42.
The next day, you decide to close the transaction.
At that time, the contract price reached USD80.23 for purchases and USD80.22 for sales. So, the transaction is closed at the current price of USD80.23. Obviously, you get more profits.
CFD Trading can provide a good alternative for traders, both short and long term traders.
However, every trader who enters the CFD market must also weigh the advantages and disadvantages.
In addition, it is also important to make a trading plan, because trading with a directed plan can keep traders in the market with consistent trading results.