Benefits of CFD Trading
Capital market volatility has affected all asset classes and is driving demand for leveraged financial products. Contracts for Difference (CFDs) are financial instruments that track many assets, including Forex currency pairs, individual stocks, commodities, indices, and cryptocurrencies. CFDs allow you to trade in the capital markets using leverage.
What is a Contract for Difference (CFD)?
A Contract for Difference (CFD) is a financial instrument that tracks the movement of an underlying asset, such as a stock, currency pair, commodity, cryptocurrency, or index. It differs from the underlying instrument in that you do not need to invest the entire amount of capital to buy the underlying instrument. Instead, it is sufficient to cover the price change between entering a trade and exiting a trade. This is comparable to a stockbroker who may require full collateral for the order to buy shares. In some cases, when buying CFDs on stocks, you may be eligible to receive dividends provided by the company on the underlying stock. CFDs can be used to trade directly, or you can buy one CFD, sell another CFD in parallel, and fix the change in relative value.
CFDs have built-in leverage that will differ from broker to broker and asset to asset. Leverage is a function that increases trading profits, as it allows you to increase controlled capital with borrowed funds. For example, some brokers will allow you to buy $ 4,000 for Euros, leaving only a $ 10 deposit.
To use leverage, you need a margin account. Each broker will have different criteria for opening a margin account. As a rule, you need trading experience and investment knowledge. It is important to understand how leverage can affect trading profits. To buy $ 4,000 for Euros using a leverage of 1: 400, it only takes 0.25% ($ 4,000 * 0.0025 = $ 10) to double your deposit or destroy capital.
Thus, while a lever is an attractive tool, it can be a double-edged sword. When opening a margin account, a Forex broker requires that there is always a certain amount of capital on the account. Each time a new trade is opened, the broker will require a certain amount to be placed, which is called the initial margin. The required margin is the amount of capital required for the CFD price to change more than normal. The broker wants to make sure that there is enough capital set aside for the trade so that if there is a larger than usual price change, there is funds to cover losses. In modern trading terminals, all this happens automatically and instantly.
As the market moves, the amount of margin that needs to be held against each trade will change. If the price of an asset moves against the direction of the order, the broker takes a maintenance margin to cover additional losses in addition to the original margin. If the value of the security moves in a plus, the initial margin will remain unchanged, but any service margin received will decline. The margin is calculated in real time, and the broker knows the minimum amount of capital that must be in the account to continue holding the position. If the deal goes negative and there is no way to increase the capital that is on the account, then the broker will have the right to start liquidating the position.
The margin agreement provides the broker’s right to liquidate a position. Trading CFDs in relation to stocks can be very effective for investors looking to trade stocks. This is because the leverage used in CFD trading is much higher than the leverage that can be obtained from a stock broker. For example, Amazon shares are trading at around $ 1,800 per share. This means that it will take $ 1,800 just to buy one Amazon share. Many CFD brokers offer 20-1 leverage, which will allow you to buy 1 Amazon share for just $ 90 per CFD. A 5% increase in Amazon stock price will double the deposit. In addition, for the same $ 1,800 that will allow you to buy 1 Amazon share, you can buy 20 CFDs on Amazon. Finally, CFDs allow you to sell stocks without having to borrow.
Management of risks
Trading CFDs can be risky, especially when leveraged, so you need to have a plan before each trade. To avoid the risk of ruin, you should limit the amount of capital for each trade, to 5-10% of the portfolio. For example, if you plan to trade a $ 5,000 portfolio, the maximum amount you must place for each trade should be $ 500.
This will provide a strategy that will ensure safety if the start fails. Another concept to follow is to cut losses and allow profits to grow. If the market moves against the position and hits the stop loss, you need to exit and wait until the next day. If the market moves positively, move your stop loss up and let your earnings rise with the market in your favor.
Contracts for Difference (CFDs) are financial instruments that allow you to trade in the capital markets without buying the underlying instrument. CFDs track underlying instruments and provide leverage to help drive profitability. They include stocks, commodities, indices, forex currency pairs and cryptocurrencies. To trade CFDs with a broker, you need to open a margin account. While leverage can significantly increase trading profits, it is a double-edged sword and can lead to significant losses as well. There should be a well thought out risk management plan to be used on every trade before risking your capital.