What is a CFD and what is CFD trading?

What is a CFD and what is CFD trading?

Contracts for Difference or CFDs as they are being called, are financial products with which you can profit when the prices on the underlying asset go up or down. These underlying assets can be: indices, stocks, currency pairs (forex), commodities and nowadays also crypto.

A CFD is a contract between buyer and seller. In most cases, the seller is the CFD broker and you are the buyer. The buyer never becomes the owner of the underlying asset, but is entitled a profit(or loss) when the price rises or falls. This profit or loss is calculated the moment you close your CFD position.

Interesting read: Plus500 review

With a CFD you, as trader, can bet on a rise (long) or fall (short) in price of a stock but also the price of gold or a Bitcoin.

By buying a CFD you basically virtually buy a stock.

What are the advantages of CFD trading?

The biggest advantage of CFD trading is that you don’t need the full amount as down payment for the underlying asset, but that you can make use of leverage. Because of this, you can open positions bigger than your deposit or account balance.

The big pro of this is of course that you can make more profit when the price of the underlying asset moves in the right direction. The big disadvantage is of course, that you also suffer a bigger loss when you’re wrong and the price moves in the opposite direction.

This risk you can mitigate by using a stop loss. A stop loss is sort of an emergency brake that closes your position automatically at a certain price (determined by yourself).

Trading CFDs required a minimum margin requirement, so you can cover your potential losses. This is a sort of insurance for your CFD broker, that ensures you can keep your positions open and won’t go in minus (negative balance).

Some more CFD trading pros:

+ Very low transaction fees
+ Use of leverage
+ Profit on both price rises and falls
+ Loads of assets like stocks, commodities, crypto etc.
+ Most CFDs don’t have an expiry date. You decide yourself when you sell or close positions.

Example of a CFD long trade

A CFD trade is the entire process of opening a position until closing it. In the example below I show you a trade on Netflix stocks using a CFD.

how do cfds work netflix example

In this example I have $5,000 on my CFD account. I buy a CFD for 20 stocks Netflix at $390 with a leverage of 1:10. I sell the CFD again when the price hits $400. This is how the CFD trade looks on paper:

– The value of this position is 20 x $390 = $7.800
– The leverage is 1:10
– The margin requirement is 10%, = $390
– There are no transaction fees
– I sell the CFD when the price of Netflix shares hits $400
– My net profit is $400 – $390 = $10 x 20 = $200.

This might seem complicated, but on trading platforms the broker automatically calculates this for you. Nevertheless, it’s good to know how a CFD transaction works ”behind the curtains.”

Open Plus500 demo account

One of the best brokers to practice CFD trading with, is Plus500.

Hopefully this article gave you the insight and the answer to the question: what is a CFD and how does CFD trading work?

If you have any other questions regarding CFDs and CFD trading in general, feel free to ask them in the comment section below or by the live chat messaging system.

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