What is CFD?
CFD (Contract For Difference ) CFD (Contract For Difference) is a contract for a price difference. The sale or purchase of a financial instrument under CFD does not imply documenting the rights to it (that is, you certainly have the right to enter into a contract, but you do not have rights to the subject of this contract). That is, if you, for example, entered into a CFD contract for the purchase of 1000 shares of Microsoft, you will not become their owner, and these shares will not become your property. Then why make such a deal?
In fact, everything is very simple - the deal is only to obtain the difference in price. And this, in turn, is done either for hedging purposes or for speculative purposes. If you are not a long-term investor and your goal is only to earn more money in a limited period of time, by buying cheaper and selling at a higher price, then why should you own the shares? After all, it’s much easier, in the hope of a price increase, to buy a couple of CFD contracts for these same shares, and when the price rises, close them with a profit of the difference between the closing price and the opening price, minus a small broker's commission. At the same time note that you do not have to spend money to include you in the register of shareholders and other exchange fees for access to the market.
CFD contracts were created with the goal of maximally simplifying the work related to the procedures of bought-sold. More precisely, they were created for the purpose of hedging shares on the London Stock Exchange, but they could not be better suited for speculative trading. Indeed, in addition to the above, they have a number of significant advantages such as:
- Low trading deposit
- Ability to use large leverage (up to 1: 100). By the way, large leverage can be a minus - it's a win-win situation
- By signing a CFD for the purchase of shares, you are entitled to receive dividends on them
- Extensive portfolio diversification opportunities are especially relevant for traders with a limited budget
- A large number of financial instruments for which you can enter into CFDs (from stocks to corn)
CFD Trading Principles
CFD simulates the profit and loss of a real transaction to buy or sell an asset. The contract provides the opportunity to trade in the underlying market and make a profit, without actually owning the asset itself.
Suppose you expect the skyrocketing oil price to continue and want to buy 1,000 shares of Exxon Mobil Corporation (XOM), the largest publicly traded oil company in the world. You can buy these shares through a broker by paying a significant part (according to the regulations of the Federal Reserve System, at the moment, the size of the initial margin in the USA is 50%) of the full value of these shares, and for the rest, take a loan from the broker, and moreover, pay a commission to a broker.
Margin trading allows you to take a more voluminous position in the market with a small amount of invested capital. When the market moves in the direction you are expecting, the profit with the leverage provided increases as you have contributed only a fraction of the total value of the contract, and the profit will come from a change in the total value. Of course, with margin trading, losses can also increase significantly if the market goes against the movement you were counting on. Therefore, care must be taken when trading with leverage: risk management becomes an especially important aspect.
Intraday trading is the process of buying and selling various assets within a single trading day. This means that during this day the trader or investor can make any number of trade transactions at his discretion. Since margin trading allows you to increase the position with a limited amount of invested funds, CFD trading is possible with small fluctuations in the asset price in one day.
Opportunity to trade with growth and falling prices
CFD is a flexible investment tool. If you are confident in the growing market, then get income by opening a position to buy CFDs. You can also speculate on price cuts by selling CFDs. Holders of open positions for the purchase of CFD on shares receive a dividend amendment equal to the dividend payable, if at the time of opening of trading on the day of payment of the amendment (coincides with the ex-dividend date) the instrument has a long position. On the contrary, the dividend amendment is withheld from the client’s account, if the position to sell the CFD is open.
Investment portfolio hedging
If you assume that the acquired shares will become cheaper, but you do not want to sell them, then you can use risk hedging strategies by opening a position to sell CFDs on your stock portfolio. Thus, the profit from a short position in CFD will compensate for losses from the fall in the value of assets in the portfolio. You will incur lower costs compared to hedging the sale of real assets, to buy them cheaper later.
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