What are CFD’s? Introduction about “Contract for difference”
Definition of CFD – CFD or ‘Contract for difference’ means an arrangement in which differences encountered in the futures contract are dealt through cash settlements instead of physical goods and securities.
CFD’s are easier ways of settlements as the losses and gains incurred during a contract are paid in cash. This allows traders to experience all aspects of security trading without actually owning a security.
CFD traders have the liberty to invest in both domestic and global shares as well as other assets like foreign exchange, indices and commodities.
CFD’s being a derivative does not give a trader the ownership of a share or security. The trader gets profit or loss on the movement of share price as the CFD’s are like mirror images of price fluctuations in a security. The trader is not accountable to any voting rights as he physically does not own a security.
Buying a CFD (official term ‘going long’) means that the trader believes that a security is going to rise and selling a security (going short) implies that the traders thinks the security is poised to fall.
The simplicity of CFD’s is comparable to that of trading shares as effectively they almost function the same way.
The CFD’s trade at the same prices as the shares and thus has similar profits and losses. The main difference between the two forms of trading is that the CFD’s are bought through borrowed money and shares are actually by the traders through their own investments.
CFD’s have an added advantage as the brokers would allow you to have leverage on the trades thereby trading on margin. This allows the traders to have more profits than their respective investments, although it also accentuates the risk of losses.
The trader just has to pay about 5 to 10% of the actual security price and the rest can be borrowed by the broker.
Like any other trade involving investments CFD’s too require the trader to be sensible. The traders must be adept in money and risk management to actually keep money in their hands.
The trader may not earn much even if he gets lots of successful trades, if he is incapable of managing his money.
The trader must thus manage his interest costs, losses and calls he places on margins so that they do not mount above the actual deposit made by the trader, indicative of a loss.
The trader must obviously utilize all techniques available at hand to minimize his losses. To reduce the risks associated with trading CFD’s the trader must invariably employ stop losses.
They are basically orders that are set by a trader at a predetermined price at the initiation of the trade that would activate a sell or going short option when the CFD passes through this set price.
This process when employed significantly reduces the risks of probable losses or is at least capable of cutting short the enormity of losses that the trader would have to suffer otherwise.