Offering high leverage options and a variety of financial markets, CFD trading is certainly a captivating choice for investors. But what is CFD trading exactly? 

To help you understand the concept better, we’ve put together a quick guide about CFD trading, covering everything from definition to example scenarios. Read on to discover the basics of CFD trading and see if it’s the right investment for you!

What is CFD Trading: Definition 

First, let’s establish what CFDs are. A CFD (Contract For Difference) is a contract between an investor and a broker to pay the difference in an asset’s price between a position’s opening and closing times. 

CFDs are considered derivative products, as they allow you to speculate on financial markets without actually owning them. 

CFD traders will buy a certain number of contracts if they expect the price to rise, and sell them if they expect the price to fall. 

What is CFD Trading: How it Works

CFD traders will first open a position in a particular market. Let’s take buying gold as an example.

Traders can close the position to turn a profit if the price of gold rises. But if the price falls, traders will end up with a loss when the trade is closed. 

Designed to replicate underlying assets, CFDs are quoted in the same currency and have the same trading hours as the underlying market. 

What is CFD Trading: Short & Long Explained

An attractive feature of CFD trading is that traders can speculate on price movements in both directions. Profit or loss depends on how accurate your predictions are. 

Just like a traditional trade, you can profit as a market increases in price, but you can also profit as the underlying market decreases in price. 

If you buy at a specific price in hopes that the market value will rise, you are essentially “going long”. 

On the other hand, you could sell borrowed shares, promising to return them after buying them back again when their prices fall (if your prediction is correct). This method allows you to profit from the difference and is known as “going short”.

What is CFD Trading: Example

Let’s use Company ABC as an example and break down what a profitable and losing scenario would each look like.

Imagine that Company ABC is trading with a bid price of $400 and an asking price of $405. You seize the opportunity to buy 100 stock CFDs for $40,500. Since the company’s margin requirement is 10%, you deposit $4,050 (10% x $40,500). 

What is CFD Trading: Profitable Scenario

In this positive scenario, the trade is profitable because the bid and ask prices both rise the next day. You close your position at the selling price of $430.

By taking the difference between today’s sell price ($430) and yesterday’s buy price ($405), you now have a profit of $25 per share. Your total profit is $2,500 (before deducting commission fees) since you have 100 shares. 

What is CFD Trading: Losing Scenario

Here, the stock CFD prices fell to $370 (bid) and $360 (ask). Taking the difference between today’s sell price and yesterday’s buy price, you find out that the price dropped by $35. 

Multiply that number by 100 shares and you will have the total sum that you lost: -$3,500. Let’s not forget that you still have to pay commission fees despite not profiting in the trade. 

Considering that you deposited $4,050, you lost more than half of what you invested. 

However, with proper research and a good strategy, even beginners can learn to avoid making mistakes that would lead to negative outcomes like this. 

What is CFD Trading: Why Trade CFDs

One obvious benefit of trading CFDs is the fact that investors don’t need to purchase assets with capital in order to trade. 

They can speculate on the movements in the market price and reap potential benefits without the cost of actually owning these assets. 

Besides that, CFD online trading platforms like MetaTrader 4 and MetaTrader 5, enable near-instant trading. Traders can buy and sell CFDs multiple times a day as well with these efficient platforms built for speed and flexibility. 

Hence, investors seeking short-term trading opportunities would often favor this popular approach to trading. 

With this helpful guide, we’re sure that you now have a better understanding of what CFD trading is. But did you know that CFD trading and forex trading share a few similarities? They are both highly leveraged financial instruments with the potential for greater profits.

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