CFD trading for beginners
CFD and spread trading are similar in many ways. Both are exciting, and both are also high risk so not suitable for everybody. CFD and spread trading use leverage which means that you only have to deposit a small percentage of the total value of a trade in your account to control a large amount of the underlying market. At Trade Nation, CFDs are available on our MT4 platform, and unlike spread trades, CFDs have variable spreads. Nevertheless, CFD trading could be ideal if you’re looking to speculate on financial markets in the short to medium term as they are typically held open for only a few days or weeks, rather than for longer periods.
What is CFD trading?
CFD stands for “Contract for Difference”. CFDs are financial derivatives which mean that they ‘derive’ their prices from an underlying asset such as an individual share, a stock index, a currency pair or a commodity such as gold or crude oil. A CFD trade is an agreement where one party pays another party the difference in value from when the CFD trade was opened to when it was closed. And you can sell a CFD as easily as buy one. This means you can look to profit from a falling market as easily as you can speculate on it rising in price.
History of CFDs
CFDs were first devised in London in the 1990s. Initially they were used by hedge funds wanting to protect themselves against falling share prices without selling the stocks in their portfolios. Fund managers found that CFDs could be used as an easy and cost-effective way of limiting losses from falling stock markets. This practice is known as going short, that is, selling something that you don’t own.
Traders soon realised that CFDs were the perfect vehicle for speculating on stock price movements, not just hedging. Then the industry expanded dramatically as CFDs became available on all kinds of financial markets, and not just individual shares.
Trading on margin
As mentioned earlier, CFDs are a leveraged product. This means that you can control a large amount of a financial asset while only putting up a small percentage of the total underlying market exposure as a deposit, or ‘margin’.
For example, let's say that Trade Nation’s margin requirement for a particular stock index CFD is 1%. This would mean you only have to hold $200 in your account to control a position worth $20,000. This gearing means that CFDs offer the potential for significantly larger profits than standard unleveraged trading. However, it is important to recognise that there is also an offsetting risk of incurring large losses.
5 reasons why you should trade CFDs?
1: With CFDs you have the opportunity to profit from the rise or fall of a market without having to own, or sell, the underlying asset
2: CFDs are leveraged products, and you only need to deposit a percentage of the total value of your position to control all of it.
3: You can go long or short on over a thousand different markets from a single account when trading CFDs and you can monitor your positions in real-time.
4: There’s no need to instruct a broker to act on your behalf.
5: CFDs give you the ability to trade in small stake sizes to suit your appetite for risk.
CFDs open up opportunities to speculate on over a thousand different financial markets from a single account. They employ leverage which means profits and losses are magnified. Consequently, you should never speculate with money you can’t afford to lose. It’s also important to understand what it is you’re trading and have a plan in place before you open a position. But given all this, CFDs open up a gateway to the exciting and fast-moving world of financial market trading.
Read next: CFD trading explained