What is a Contract for Difference-CFD Trading Explained

cfd trading

A contract for Difference(CFD) trading is a form of derivative trading. In business, derivatively refers to an agreement between two parties on an agreed upon the underlying financial asset. CFD trading is a tool that allows both the parties to invest through an investing app like https://capital.com/  in an asset without owning it. This contract is between two parties that is the buyer and the seller. In CFD trading seller pays the buyer the difference in the current value of the asset and its value at the time of contract. If, however, this difference is negative the buyer pays the seller instead. So, both the parties can take advantage of the prices of the asset going up or going down. If you think that prices will rise go long, that is buying the asset or go short that sells the asset if you think otherwise. The asset can be a substantial share, currency pair or commodity.

In CFD trading none of the two parties buy or sell the underlying asset, they only buy or sell units. As the price of asset moves in the party’s favor the party gains multiples of the number of CFD units that it has bought or sold. Similarly, with each point moving against it, the party makes a loss. Sometimes the damage may exceed the deposits.

Margined or leveraged trading

In CFD trading a small amount of the total value of the contract is paid which means that with a small amount of money you can control much more significant amount which can magnify your investment in case of profit. However, the loss magnifies as well as far as profit does.

How does CFD trading work

Wanted to know how to trade CFDs? Just keep reading…

CFD trading works on the following steps:

●       Choose your financial instrument

Choose the instrument like USD or UK 100 that you want to trade on.

●       Go long or go short

Go long(buy) if you expect the prices to rise or go short(sell) if you think otherwise.

●       Select your trade size

The value of one CFD unit varies according to the instrument. Decide how many units you want to trade.

●       Don’t forget the risk

Keep in mind the margin product. The higher the margin requirement, the riskier the market. You must have enough funds to recover any losses.

●       Judge your position in the market

After placing your trade look at your open positions including any stop orders or take-profit orders to keep track of your real-time profits or losses.

●       Closing your position

A trade is shut automatically because of stop or take-profit order if however, it is not close your trade when you are ready.

Closing you trade

If you do not have enough funds to keep your trade open and are now at a risk of being closed automatically, you will find yourself on a margin call. City Index (a CFD trading provider based in the UK) closes out positions when the funds drop below 50% of the trade’s margin requirement. There  are three situations:

Sufficient margin

If your margin level is higher than 200%, it means you have enough funds to keep your positions open in the trade.

Trade at risk

With margin level below 200%, your trade may fall further and thus automatically closed out.

Insufficient margin

With a margin level below 50%, you do not have sufficient funds to cover your total margin, and your open positions may be closed.

Avoiding margin call

In case of a margin call you can take following steps:

  • Immediately close out your trade.
  • Reduce the size of your position to free some equity in your account.
  • Add more funds to cover the shortage and bear some further losses.