CFD or contract for difference is a financial instrument where you can trade without having to own the asset. The buyer and the seller basically participate in the transaction wherein the trading is based on the movement of the price of the shares and not on the stocks itself. If the share price rises during the CFD course, then, the seller will pay the price difference to the buyer.
On the other hand, if the share price is lower during the closing of trade, then the buyer will have to pay the price difference to the seller. It is just the monetary difference in value which is being transferred during the trade, not the share itself. However, the CFD price is the same with the actual share’s price.
There are other sole features of trading that must be understood if you are one of those who considers to begin with this trading type.
Leverage and Margin
Compared to other trading types, CFD basically has a lower margin and higher leverage requirements. Leverage means that a trader uses money borrowed from a broker for him to make more shares compared when having a starting capital. The margin is the loan from the broker. For instance, for a trader to have 5% of the total value for him to trade and receive the remaining as a loan from a broker, the amount of leverage must be 5:1 and a 5% margin.
For a CFD trading to initiate, there is a standard requirement of 2% margin. The accurate margin for a trade is dependent on the primary asset, thus the requirement for margin for shares may be up to 20%. However, this margin is still lower that the usual trading shares margin, through the actual shares buying and selling.
In CFD trading, lower margin means that the investor is only required a less capital to start. Thus, this kind of trading gives greater possible returns with regards to the initial capital of the trader. But the traders must be fully aware that losses from here with a low margin can rapidly amount to over the beginning capital that was invested.
Therefore, it is suggested to only take a small percentage of risk of the total capital trading on any trade in the brokerage account.
Instead of charging fees or commissions for CFD trades, brokers necessitate that traders will pay the spread. Spread is the difference between the ask price and the bid price.
Having to pay spreads on the entry and exit points means that small movements of price are not as profitable for CFD compared to stocks. Paying spreads will result in lesser return on winning trades, same with higher chances of loss for losing trades, compared to stock trading directly.
Trading and Brokers
Compared to the stock market, CFD trading markets are less regulated. Most brokers give access to every market from their own online platform. There are a lot of available CFDs in the market, like stock, CFDs and commodities.