CFD trading has grown exponentially in the past few years, and it has proved to be particularly valuable tool for trading stock without the need to buy shares out rightly. Since they are tradable by margins, they come highly recommended to investors willing to venture into higher risk investment. While trading CFDs, you need to pay interest on a daily basis. Rates differ between various brokerages and individual trading specialists.
From the derivatives in equity, CFDs allow investors to speculate on the movement of the shares, without having to own the shares. The use of CFDs started out in the London stock exchange in the early 1990’s and has grown by leaps and bounds since then. They are now available throughout continental Europe’s major companies that include FTSE 350, DAX, and ATX amongst other companies from other parts of the world. They however are not allowed in the United States due to the restrictions placed by the U.S Securities and Exchange Commission that bar over the counter financial transactions.
A wide variety of markets are tradable using CFDs including stocks, forex and bonds.
An example of a CFD Trade
Although CFDs fundamentally fulfil the same role as a share purchase, as we can see, leverage means the original sum of money needed is much less. The following example shows this:
Lesley wants to buy a contract worth $20,000 in the company Blue Widgets PLC that is currently trading at £10 a share. Her position is the equivalent of 2000 shares although the Contract For Difference broker she uses only has a 10% margin requirement to open the contract. This means she only needs $2000 to open the position. If the price of the underlying share rises to £15, she will have made $10,000 (from just a $2000 initial deposit). This goes to show the power of leverage and the benefit CFD Trading has over many other methods of investment.
Other Points to Note
Contract for Difference or CFDs as they are popularly known are traded over the counter (OTC). These are good trade options as they allow you to leverage your returns. There are both long-term and short-term options for this kind of arrangement. Traditional share trading involved a stockbroker and entailed making payment of the full purchase price. With a CFD however, it is possible to achieve this with less cash involved. How, you may ask. A typical CFD allows you to trade in most markets from only around 1% to 10% margins. Some markets offer 20% and up 50% times the exposure, multiplying the risk involved. This is akin to borrowing to trade; the trick here is to extrapolate the gains or losses by the factor of 10—taking 10% as the operating margin requirement. For instance, a 3% increase in a share price will result in a 20% return on your initial outlay. This is because prices follow the underlying stock quite tightly, so the difference is hard to spot.
CFDs are normally traded between individuals and CFD traders of brokers. There are no universal terms for CFDs as both parties agree on their terms and conditions to apply throughout their transactions. However, they are prevalent practices that cut across most CFD transactions. One of the major benefits in trading Contracts For Differences is that they can be traded on a margin. This means that they can be used to provide the trader with a larger leverage. It involves taking a small deposit and using it as leverage borrows larger equivalent quantity of assets. Say for instance you want to buy shares worth €25,000, and the margin rate for those particular shares is 10%, then all you need is to deposit €2,500 while maintaining the same level of exposure.
Trading CFD like any other trade involves risks. However, risks in this venture are higher compared to normal trade practices. This does not mean they cannot be controlled as several mechanisms have been put into place to cushion the trader from losses including the automatic termination of a contract if it moves below a specified loss making mark. This makes it an attractive option for budding businesses and based on its versatility, it grows your investment quite dramatically especially if used to hedge against the decrease of shares you might actually own. CFD’s are of many types ranging from individual, to index CFDs and finally to currencies, which provides more chances to make a quick buck.
Article by FinancialTrading.com
