What Is CFD Trading and How Does it Work?

Modern tools allow anyone to buy and sell on the global markets. Through high-end platforms and apps, traders can access currency pairs, stocks, and assorted derivatives. CFDs are a profitable asset for players with financial foresight. They are also a perfect addition to diversified portfolios. Here is why.

Trading on the physical stock exchange has its own drawbacks. Participants buy and sell shares issued by major corporations, and their financial result depends on these companies’ performance. CFDs allow you to speculate on the same assets, but indirectly. What matters is the price alone. You do not become a shareholder. Discover how the scheme works in South Africa.

Definition of Contract for Difference

So, what is CFD trading all about? A Contract for Difference is defined as a special contract between the broker and its client. This agreement stipulates that the seller will receive the difference between the current value of an asset and its value at a certain time in the future. These derivatives may be linked to different underlying assets. Popular examples are:

• shares;
• market indices;
• commodities;
• cryptocurrencies;
• currencies.

A trader can profit from any trends. Both downward and upward movements can result in tangible gains. The goal of a client, therefore, is to predict price dynamics for the underlying asset and execute trades at lucrative moments.

Examples: CFD on Crude Oil

No barrels of WTI are bought or sold as part of CFD transactions. Unlike futures, CFDs are not connected to physical delivery. Holders trade the instrument depending on their predictions of the oil price.

Changes in the oil market receive comprehensive coverage in the media. Thus, traders have enough information to base forecasts on. Choose a commodity you know and make money with CFDs. These instruments may be linked to precious metals, wheat, etc. 

Key Advantages

In many respects, CFDs are similar to other trading instruments. They have a few notable advantages. Let’s look at each of these points closely:

• trading on margin;
• long and short positions;
• effective diversification.

Leverage (Trading on Margin)

Global brokerage brands like Forextime provide affordable entry to the marketplace. The minimum deposit requirement for CFD accounts may be as low as $100. However, clients can open positions for more than they deposit.

Leverage is an arrangement that allows a trader to use a portion of their broker’s funds. This is based on a certain ratio. For instance, 1:100 means you can buy and sell CFDs worth $10,000 with just $100 (margin) on your balance. This scheme increases potential gains. Discover attractive conditions for CFD trading for South Africa today.

Long and Short Positions

Going short refers to selling. If traders expect their assets to lose value, they may sell them before the fall. This way, it is possible to buy more lots later for less. On the other hand, if traders anticipate a rise, they go long. This means they purchase the asset in question and capitalize on the uptrend.

Importantly, no physical assets ever change hands. CFDs are purely virtual tools that rely on price dynamics. Participants can speculate on commodities, stocks, etc., without owning any. This gives unlimited freedom of choice. Choose CFDs on the asset you understand best, and monetize your knowledge.

CFDs for Diversification

CFDs are a common element of wide portfolios. Any professional knows the value of diversifying. Traders and investors who focus on a single asset have to accept higher risk. When the risk is spread across different instruments, it is lower. CFDs are an effective hedging tool.

Suppose you are a trader who prefers a particular currency pair. Sudden shocks in the market may cause your investment to dwindle. However, if you can still make profits elsewhere (e.g., from CFDs or shares), these may outweigh the loss.

CFDs on market indices add another layer of diversification. These instruments rely on baskets of stocks, rather than separate shares. For instance, the S&P 500 includes share values of 500 largest companies in the US. Thus, its value is highly unlikely to ever fall to zero.

Word of Caution

Traders should be prudent when using leverage. The scheme is undeniably attractive, as it allows higher returns. However, risks rise along with profits. Thus, clients may wipe out their accounts if they are underprepared. Trading on margin requires experience. Its use must never be foolhardy.