Are you ready to expand your forex trading skills to other financial assets? Here’s a newbie-friendly guide to what CFD trading is all about!
What is a CFD?
A CFD, or contract-for-difference, is a financial derivative that allows traders to profit from price movements instead of actually owning an asset. It’s essentially an agreement between two parties to pay the difference between the underlying asset’s current price and its price when the trade is closed.
How do you make money with CFDs?
In CFD trading, you make money by multiplying the underlying asset’s price difference by the number of units in your contract. For example, you bought 100 gold CFDs for $1,200 and then sold them at $1,400 after a few months.
Not counting transaction costs, your profit should be (($1,400-$1,200)*100) = $20,000. The same computation applies if you shorted an underlying asset instead of buying it.
How do CFDs compare against other financial assets?
First, the similarities. Like trading options and futures, there’s a wide range of underlying assets you can trade. Popular choices include stocks, commodities, and indices. Since they all depend on underlying asset prices, you’re also exposed to market risk. You can also take advantage of leverage when trading CFDs. Take note though, that this also exposes you to liquidity risk and may get you margin calls.
CFD trading is different from spot FX in that you can trade assets other than currencies. This means that what’s important for forex trading (economic events, technical breaks, etc.) may not be as important to your CFD trades.
Options trading is a bit more similar to CFD trading. One of the key differences is that options have expiry dates and CFDs don’t. It’s a good advantage to have if you don’t put stop losses on your trades. If you recall, losses when buying options are only limited to the option premium paid.
What major trading risks should I be aware of?
Remember that all forms of trading involve risk, but dealing with derivatives can be trickier for trading newbies. Make sure to check with your local regulatory bodies to see their policies on CFD trading.
Also, don’t forget to read your broker’s terms regarding leverage, commissions, rollover computations, and other transaction costs. Once you’ve found a good CFD broker and tried out their demo accounts, then you’re on your way to expanding your trading basket and your trading skill set!