CFD or contract for difference offers traders and investors the opportunity to take advantage of price movement without owning the underlying asset.
What are contracts for difference?
A CFD is an over the counter derivative contract, under which two parties agree to exchange the difference between the opening and the closing value of the contract, with reference to an underlying security that is traded on margin. In other words, CFDs allow traders to speculate on the rise or fall of securities, without needing to own the underlying product.
As CFDs are a leveraged product, traders are required to deposit a certain amount of cash as security for exposure of the CFD position, rather than paying for the full value of the underlying position. For example, when trading CFDs, you can leverage at a ratio of 10 to 1, which means for every $1.00, you can gain exposure to $10.00 worth of CFDs.
As a general rule of thumb, the higher level of risk you take, the more skills, knowledge and experience you need to manage the risk. So when trading CFDs, you need to ensure you have:
- A good understanding of your risk and money management rules,
- Know stop-loss management,
- A trading plan with tested and proven buy/sell rules,
- An understanding of how CFDs work and how to trade them, and
- Know where and how to learn about CFD trading.
Benefits of trading CFDs
While there are a number of risks associated with trading CFDs, there are also benefits, which include:
- CFDs are cost effective because they can be traded on margin;
- Provide flexibility because you are trading on the price movement of the underlying share or index without physically owning it;
- Profit potential from falling as well as rising markets;
- You have the option to trade shares, sectors or indices;
- You can trade 24 hours a day in global markets
- You can use a guaranteed stop-loss facility to minimise any losses