CFD (Contract for Differences) is a popular trading instrument; it is a contract for differences between the current value of the basic asset and its price at the time of the contract end. Shares, precious metals, energy resources, currency pairs, indexes, or commodities can be a basic asset.
In this case, there is no transfer of property rights. CFD provides an agreement between a trader and a contract holder. According to it, a holder is obliged to transfer the difference between the asset value at the current moment and at the time of expiration.
Why is it profitable to trade CFDs?
Trading contracts for differences is very popular today, because it has many advantages like:
- An ability to make a profit regardless of rise or fall for the base asset's price;
- A wide variety of trading instruments;
- An ability to trade on commodity and stock markets without a basic asset or large amounts on the account;
- Low margin requirements.
Traders who practice CFD trading prefer to trade several trading instruments at once. This will reduce investment risks in case the asset price becomes disadvantageous for a trader.
Brokerage firms offer to trade contracts for differences using leverage. In this case, a trader needs to pay a certain percentage, but at the same time, opportunities to make a profit increase significantly. This is also one of the advantages of CFD.
Depending on the selected basic asset, various types of contracts for differences can be selected. The most popular ones include contracts for shares, stock indices, and goods.
CFD for shares
In this case, shares of companies, listed on the exchanges, are the basic assets. Traders earn on the price movement for a certain type of securities. Since there are no ownership rights transferred, a buyer doesn't need to transfer funds to a foreign country or convert them into dollars. There are no additional expenses (usual for shares trading) that include the exchange services, depository, registrar, etc.
Cost of the contract for differences is equal to cost of the stock on the market. CFD shares' buyer receives all the benefits corresponding to such a financial instrument type. Dividends are also earned on shares bought under CFD. However, they are usually paid to the broker for leverage.
CFD for indexes
This type of contract is a specific trading instrument. A trader can get profit from differences in the values of stock indexes. In this case, any exchange index is a basic asset. According to the terms of the contract, each item of the selected asset is equal to a certain value. For example, the parties agree that each point of the Dow Jones index will be equal to $0.05.
A feature of index CFDs is a high profitability level associated with a high trade risk. During the one trading session, the stock indexes value can vary by several thousand points. In case of successful outcome of the transaction, a trader can earn a decent amount. Otherwise, he will also suffer great losses.
CFD for goods
Trading CFD contracts for agricultural goods and energy resources is also very popular. In this case, traders earn on changes in the value of these assets. If there is no certainty regarding the price direction, the CFD traders use contracts for differences to hedge their risks. They create cross-transactions, i.e. contracts for sale and purchase of goods. Thus, whatever direction the price goes to, a trader will be able to profit and cover losses.
However, contracts for differences involve high risk level despite all the advantages. Therefore, it is worth practicing on a demo account before you start to trade CFD.