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CFD Trading – Things You Should Know
You may know the meaning of CFD. But if you don’t know what is CFD, it stands for contract for difference. It enables you to take a position on the cost of an instrument without having to actually own the asset. One of the most attractive features of CFDs is that they allow you to gain a profit from rising markets as well as falling ones too.
As its name implies, a CFD creates a contract between two individuals or companies on the changes of prices of an asset.
CFDs are a Derivatives Product
The meaning of this is that you don’t have to actually own the asset but you’re just speculating on if its price will fall or rise.
Here’s an example of stock investing. You’re planning to buy 10,000 shares of a company and the price of the share is 280p; thus your total investment would be £28,000, excluding the commission and other fees charged by your broker for the transaction. In return, you get a stock certificate, which is a legal document that confirms that you own the shares. This means that you have something physical in your hands till you decide to sell it, most probably for a profit.
However, with CFDs, you don’t own those shares. You just have to speculate from the movement of the share price and potentially profit from it.
CFDs are Leveraged
The meaning of this is that there is a much larger market exposure for you for a comparatively small starting deposit. Thus, your return on investment is considerably larger than that in other types of trading.
Let’s again take the above example of shares. Those 10,000 shares cost you £28,000 and don’t include any additional commissions or fees. On the other hand, with CFD trading you need only a small percentage of the full trade value in order to open the position and preserve the same level of exposure. If one of the CFD trading platforms offers you 10:1 leverage on those shares, a deposit of initial £2,800 to trade the same amount will be all you’ll have to put in.
If now these shares rise by 10% to 308p, the position’s value is now £30,800. Thus with a starting deposit of only £2,800, this CFD trade makes a profit of £2,800 which is 100% return on investment for you as against just a 10% return if you would buy shares physically.
However, you should remember that while profits in CFD trading are huge, losses are huge too. Thus if the prices move against you, you may be closed out of your position or need to refill your deposit to keep it open.
So, understand well what is CFD trading and start it preferably under the guidance of a pro so as to avoid massive losses.
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