Investors can now opt for the CFD (Contract For Difference) to trade on the financial markets. CFDs are relatively new on the investment market. In a short time, the demand for CFD trading has exploded. But what is a CFD and where can you trade it?
What is a CFD?
CFDs or Contracts For Difference are investment instruments with which enables investors to respond in a straightforward manner to price fluctuations in multiple markets. The underlying asset can be a share, index, commodity or currency. CFD is a leveraged product.
The investor enters into a contract with the CFD with the broker. He speculates on an upward or downward movement of the underlying value. The contract has no end date. The investor can conclude the contract after a few seconds or after a few years, depending on his objective. However, CFDs usually used for short time periods.
Contract For Difference means a contract for difference. How it works precisely is best explained through an example:
The investor opens a CFD long (speculating on an increase) with an underlying value of 1 ounce of gold. The purchase of 1 ounce of gold on the stock exchange (via an ETF, for example) would cost the investor an amount of 1200 euros at a gold price of 1200 euros per ounce. To open the CFD, the investor only needs to have a certain amount of margin in his account. Let’s say that the margin percentage, in this case, is 10%. The investor must then have 10% of 1200 euros = 120 euros in margin on his account.
Now suppose that gold rises 120 euros in value to 1320 euros per ounce. The investor who has bought gold on the stock exchange then makes 120 euros profit. On his investment of 1200 euros that is a return of 10%.
The investor in CFDs receives the difference in price of 1 ounce of gold between opening of the contract and conclusion of the contract. That is 1320 – 1200 = 120 euros in this case. The profit for this investor is therefore 120 euros. The investment (margin) was also 120 euros. That therefore amounts to a profit of 100%. The leverage of this CFD was 100% / 10% = 10. We see here that the lower the margin, the higher the leverage.
So we work with margin. The investor is never in possession of the underlying asset during the term of the contract. The broker buys the underlying value on the stock exchange and requests an interest payment for this investment. This interest payment is settled per day. The fee is made up of the EONIA (European OverNight Index Average) or the EURIBOR (the European interbank rate) + a surcharge (compensation for the broker). If the investor goes short, he will receive the interest payment himself.
The CFD can not be traded on the stock exchange. The contract is entered into with the CFD broker as counterparty. In contrast to trading in shares, the investor with CFDs does run a risk if the broker goes bankrupt.
There are a large number of brokers active that offer trading in CFDs. It is worthwhile to compare the rates and the services offered. With many brokers it is possible to open a demo account, without obligation. This means that, for a few weeks and with fictitious money, you can get acquainted with trading with CFDs and with the trading platform offered by the broker.
The following brokers offer trading in CFDs:
* Trading CFDs involves risks. Do not put more capital at risk than you are willing to lose. This is not investment advice. Past yields do not guarantee the future.
What options do CFDs offer
CFD Trading offers many new opportunities to the private investor. For example, it is possible to trade 24 hours a day in a good number of underlying values. So you are not dependent on the opening hours of the fair. This is a significant advantage especially for CFDs on currencies and commodities. After all, these markets traded across the globe, in contrast to shares that usually listed on only one stock exchange. Utilizing stop-loss orders and limit orders, the investor can make use of this option to trade 24 hours a day.
Suppose, for example, that you want to take advantage of the rising oil price, but you want to invest for a maximum rate of $ 100 per barrel. The oil price fluctuates around $ 105 at that time and does not fall below $ 100 during the opening hours of the stock exchange. At 3 o’clock at night, during the trade in Asia, the oil price drops rapidly to $ 99, and then quickly recover to above $ 100. By giving a purchase order limited to 100 dollars you can purchase at the desired price while you sleep comfortably in your bed.
The same applies to stop-loss orders. These can also be specified and executed 24 hours a day.
The number of underlying values that can be traded is high at most providers. It often includes currency pairs, commodities, indices and thousands of shares listed worldwide.