A Contract for Difference (CFD) involves a contract participated by the broker and the trader. Within the contract, an agreement has been set wherein the price difference has to be paid by the losing party.
When the closing trade price goes higher than the ones paid when opening a trade, then the seller will be the one to pay the difference to the buyer. That will not be the buyer’s profit.
When opposite things happen and the asset price dips lower than the exit price then the difference will be paid by the buyer. This time the seller gets benefitted.
CFD Traders Don’t Actually Own the Underlying Asset
With stocks and bonds, traders have to own the underlying asset to trade. This means that they will have to secure a huge amount of cash before they can actually trade.
With CFD trading, there is no need to own the underlying asset or pay fees for it. Instead, trading CFD is about paying the margin which is attached to a specific security price.
In turn, this security price depends on the market value. Just as the name suggests, in the Contract for Difference, the contract is the one that profits from the difference of when the contract is opened and closed.
Commonly-used Terms in CFD
Two of the most used terms in CFD are ‘going short’ and ‘going long’. Among these two trading strategies, ‘going short’ is the most commonly used.
Knowing and understanding these terms will help you pick the right option for you. When picking, it is important that the trading strategy must suit your trading style and lifestyle as well.
Going Short – with CFD, traders have the option to open a selling position with bases concerning the price decrease of the underlying asset. When trades are made from the sell-side then it is called going short.
Going Long – when traders use CFD thinking that the price will increase, then they also hope that the underlying asset price will also go up.
For instance, a trader can expect that the oil prices will increase, therefore, he chose to go long hoping that his thoughts are correct.
Understanding the Margin and Leverage
To open a position in CFD, you don’t have to pay the deposit for the entire value of the security. What you need is to deposit a partial amount of the total value of the underlying asset.
This deposit is called margin. Because of this, CFD trading is also known as a leveraged investment product. When we say leveraged investments, it amplifies the gains or losses of the underlying asset for the traders.
Other Terms Used in CFD Trading
Spread – the difference between the ask and the bid price is known as a spread. When the trader buys, they will have to pay a higher asking price. But when selling, the bid price must be slightly lower.
Holding Cost – it is the charges that traders have to pay over open positions.
Commission Charges – These are the charges that the CFD broker asks from the trader for trading the shares.
Market Data Fees – these are additional broker-related costs that are charged for the exposure of the trading services.