CFD(Contract for Difference)(Understanding Contract Trading)
What are CFDs?
In every trade you have something called an opening price and a closing price. With CFD trading, the way you profit and earn is from the difference in the prices between the opening and the closing price.
As trading moves increasingly online, a greater number next-generation of tools are available to you, allowing you to trade without meeting a minimum capital requirement, which is prevalent among a large number of exchanges.
What do CFDs allow you to do?
As a retail-level investor, you possess multiple advantages with CFDs being available to you.
You aren’t limited by location or capital, because get access to markets across the globe.
You’re able to do both currency and commodity trading.
The leveraged trading is available with CFD trading.
Think you need lots of money to trade? CFDs allow you to enter into the financial markets with limited capital, no matter where you are.
In CFD trading, you can take long or short positions and make money on the price difference. That means you don’t need to own the asset you invested in.
So basically, CFDs allow you to profit from price differences between the opening order and the closing order, with limited capital and without necessarily having the expertise or the capital of an institutional investor.
What are the key differences between CFD and futures contracts?
While CFDs and Futures contracts do indeed possess multiple similarities, there are a few key areas of difference, which we will go into now.
The first one pertains to ownership of the asset that you are aiming to profit from the price differences on.
Just imagine two sides, two parties, the broker and you. Both sides agree on a price when the contract is opened, but everything is completed and settled at some stage in the future (which is where the term ‘futures’ comes from).
Instead of having to worry about all of this, CFDs allow you to complete it in a way that is streamlined, transparent, and in a way that is totally cost-effective.
Because of their completion in real-time, CFDs offer significantly more flexibility than futures. Firstly, you have significantly more flexibility than you would have with futures. Secondly, contracts are normally done in huge amounts, meaning that you are able to fractionalize them and get smaller amounts, and finally, you are able to use the full power of technology and crowd wisdom to get the best possible outcome, or ‘alpha’.
What can CFDs bring to me as a trading difference in this case?
Part of the beauty of CFDs is that they allow for contracts, which are done in bulk, to be traded in smaller amounts. One of the biggest challenges for individual investors previously was that the barrier to entry was set very high, meaning that they were excluded from participating in the markets. This has changed drastically with CFDs as a trading instrument.
Next up, because the transfer of ownership of the underlying asset never takes place with CFDs, that means that they can be traded anywhere in the world – You are trading on the differences in price, remember that.
Finally, part of the great thing about CFDs with the power of the Internet, you are now in a position to access different types of CFDs.
The key advantages of CFDs
Dividends: This can sometimes be a tricky one, but because you don’t own the underlying assets, CFDs do not normally entitle you to dividends. The beauty and the key advantage here is that one of the key features MoonXBT is rolling out in the coming months is dividends on stock CFDs, which you can expect to see soon.
Going Short You know the way we mentioned that CFDs offer options that don’t traditionally exist in the financial markets? If you see the value of an underlying asset going down, you can take a short position, even on certain underlying assets that do not offer options.
A prime example of this is the subprime crisis in the United States. A lot of investors saw that the market was unsustainable and took a short position on securitized debt. That meant that even though the market crashed, the investors profited.
Leverage: With leverage, you are capable of controlling thousands of dollars worth of assets with a relatively small amount of capital. With CFD trading, you are able to control a huge variety of assets, ranging from stocks to indices, to cryptocurrencies. It’s always important to remember in these cases that even as the potential for major gains is huge, the potential to make huge losses is also there.
How can I manage the risk with CFDs?
With CFDs, you are already aware that you are able to benefit from margin and leverage on your trades, but how much leverage you are willing to use depends on a few key variables, like your risk tolerance and how much money you are willing to lose (a key rule of trading is to never put in more than you are willing to lose). Another key variable here is the Stop Loss, where you are preemptively able to get out of your position when the price of the underlying asset goes above or below the amount you were hoping for.