Contracts Of Difference (CFD)

Contracts Of Difference (CFD)

Contract Of Difference is a very popular way of trading in the financial market. You can use them to trade for thousands of financial markets without the need to own the underlying asset. CFDs are derivatives which means you trade a contract derived from a price of an asset rather than the asset itself. For example, you can trade a CFD on the price of gold rather than have to buy or sell the physical commodity.

This gives you the flexibility and efficiency to build up your commerce on shares, indices, forex, commodities, and more all from one account. Thus this means that there is no need to pay stamp duty, you can pay when the market is rising or falling 24 hours a day.

How to trade CFDs

Each contract has a buy and a selling price based on the value of the underlying market. If you think the market price will go up, you buy, This is called going ‘long’, and similarly if you think the market price will fall, you sell. That’s called going ‘short’. If the market happens to move in the direction you predict, you gain profit and the more it moves in the direction opposite to your prediction, the bigger your loss.

CFD is traded on Leverage’s small deposit that gives you access to much larger market exposure. So if you want an open forex position (investing in any established trade) worth Rs. 1,00,00,000 you might need to put up Rs.50,000. Leverage comes with significant benefits and risks. The investment can go all along further but it can go lower than your deposit so when trading CFDs you should always keep an eye on the downside and manage your risk.

You can do this by placing stops and limits which close your trade automatically when the market reaches your chosen level. So you can gain your maximum potential gains and losses before you trade.

When you buy a CFD you don’t have to pay for the full value of the position but only a fraction is otherwise known as the Margin. This practice is called Trading on Margin.

By Trading on Margin, you are able though not obligated to purchase more than you normally would, this is known as the Leverage effect and the main reason why Investors like to choose CFDs. For example, let’s say stock ABC is trading at Rs.10, you think the company’s price is about to go up, so you buy 1000 CFD. Company ABC has a margin rate of 10% which means you only have to deposit 10% of the total value of the trade as position margin, so since 1000 CFDs x Rs.10= Rs.10,000

10% of 10,000= 1,000 (Position Margin)

Now let’s say your prediction is correct and Stock ABC is trading at Rs.15, your 1000 CFDs x 15= 15,000

so 15,000-10,000 = 5,000( profit)

So you made an Rs.5,000 profit on your position only investing Rs.1000. However keep in mind just like you can experience higher percent returns with the CFDs if the underlying stocks go up, you can also experience higher percentage losses if the stock goes down

Why you should trade CFDs

  1. You can gain profit in both rising and falling market
  2. Due to the Leverage effect, you can use the capital efficiently.
  3. The transaction cost is very low
  4. These are a flexible instrument that allows 24-hour trading and fast execution.

To conclude, CFD trading is a flexible alternative to traditional trading. With admission into a full range of financial markets, the CFD allows you to make money when markets are rising or falling. Investing in CFD will include lower margin requirements, exposure to global markets, and little or no fees.