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Contract for Difference or CFDs are a type of financial security that permit investors to invest in a financial asset without having to purchase the asset itself.
Essentially, CFDs are legal contracts between investors and brokers (buyer and seller) to agree to pay the difference between the current price of a financial asset and its price at “contract time”. The broker will pay the difference if it is positive. However, the investor will be liable for the difference if the difference is negative.
As CFDs derive their values from an underlying asset, they are classified as “derivatives” that allow investors to profit from the price fluctuations of an asset without having to physically own it. If prices are moving upwards, the investor can go long, whereas he can go short if prices are falling.show more
Cost of Trading with CFDs
As mentioned earlier, CFDs allow an investor to take full advantage of an asset’s price fluctuations without having to actually own the asset. This gives the CFD investor a big advantage in terms of trading costs. For example if an investor wants to speculate on the price movements of Google stocks, he would have to come up with a large investment capital as the price of Google’s stock is currently trading at more than $900 per share. An investment in a lot of Google stock would have cost the investor a capital outlay of $900,000 excluding the broker’s commission charges.
With CFDs, the investor can start trading with a smaller investment capital as leveraging trading is standard for the CFD trading industry. Some brokers only require a margin of as low as 5% meaning with just $5, the investor can make an investment with a value of $100. In short, the larger the position taken by the CFD investor, the higher will be his profit potential. Nevertheless, it should be noted that leverage trading also has the potential to magnify a trader’s loss.
The majority of CFD brokers offer trading on a wide range of underlying assets such as forex pairs, commodities, stocks, indices and treasury bonds. Hence, the correct CFD charts to use depend on a large part on the type of assets that are being traded. Each asset class has their own particular characteristics which the charts need to reflect. For example when trading forex pairs, the CFD charts used need to indicate the price movements on a short term basis. Since forex pairs are traded on an intraday basis, the timeframes on the charts need to indicate the price movements on a minute to minute basis in order for the price trends to be discernible. For bonds, the timeframe also differs, as bonds are traded on a longer term basis. In short, the type of underlying assets traded will ultimately determine the timeframes on the CFD charts used. If the trading strategy is geared for short term profitability then, the timeframe on the primary trading chart needs to be short term too. If the primary objective is long term profitability, then the investor need to rely on a CFD chart with a longer term timeframe in mind.