In this post, we’re going to look closely at one of the most popular and innovative investment tools contracts for difference mostly called CFDs. So what are they?
CFDs allow you to trade on the price movements of any financial market. Like stocks commodities indices or currencies without actually owning the underlying instrument. If you think the price of an underlying asset will go up. You can buy a CFD and benefit from that rise. This is called going long. If you think the price of an underlying asset will go down. You can sell a CFD and profit from that fall this is: short. As a result the profit or loss you make is the difference between the price when you entered your position and the price when you closed it. The more the market moves in the anticipated direction the more profit you make. But don’t forget that the position can also move against you resulting in a potential loss.
Trading on margin:
When you buy a CFD you don’t have to pay the full value of the position. But only a fraction is otherwise known as the margin. This practice is called trading on margin. On the other hand, by trading on margin, you’re able though not obligated to purchase more than you normally would. This is known as the leverage effect. and is the main reason why investors like to choose CFDs.
An example trade
the price of big company shares is currently 4.99$/5.00 dollar. You think the price will rise and want to trade five 5000 shares. So you buy at 5 dollars for 25000 dollars total exposure paying a 10% deposit of 2500 dollars which is the initial margin requirement. You pay 0.1% commission to open the trade. 5,000 shares times 5 dollars per share times 0.1% gives us a commission of 25 dollars.
It’s near the end of the day and big company shares have risen to 5.10 dollars/5.11 dollars and you decide to take your profit you sell 5,000 shares at the sale price 5.1 dollars and pay a commission on this example of $25.50 so your profit is calculated as follows the opening level of the trade was 5.00 dollars the trade was closed at 5.10 dollars giving us a difference of 10 cents.
10 cents times 5000 CFDs bought is a profit of $500 -costs of $50.50 with the Commission. So our overall profit on the trade after cost is 449.50 dollars.
Finally, here are four reasons why you should trade CFDs. First, you can profit in both rising and falling markets. Seconds due to the leverage effect you can use your capital very efficiently. Third the transaction costs are very low. And fourth CFDs of flexible instruments that allow 24-hour trading and fast execution.