CFD Trading (Basic)

A contract for difference (CFD) allows traders to speculate on the future market movement of an underlying asset, without actually owning or taking physical delivery of the underlying asset. CFDs are available for a range of underlying assets, such as shares, commodities, and foreign exchange.

CFDs were created in the 1970s in London and were initially modeled for institutional investors. They were intended to permit investment and hedge funds to leverage their market exposure and also to hedge their positions.

In the late 1990s, CFDs were introduced to retail traders. They were popularized by several UK companies, characterized by innovative online trading platforms that made it easy for individuals to trade numerous markets and assets to go short (sell) these assets, whereas in the past it was only possible to go Long (buy) and own assets.

For a clear understanding of the idea behind margin and leverage, let’s look at the price of Silver to know how leverage works when trading or investing in CFDs. Suppose you think the price of silver will rise, you can either buy physical silver or buy silver CFD.

Leverage is the use of borrowed funds to increase one’s trading position beyond what would be available from their cash balance alone. Forex traders often use leverage to profit from relatively small price changes in currency pairs. Leverage, however, can amplify both profits as well as losses.

For a perfect understanding of the concept of leverage, let’s use an example to illustrate how leverage works when trading or investing in CFDs. Assuming you think the price of Silver is going to rise from the current price of $100 per ounce and your account balance is $1000 in your unleveraged account, which implies that you can only buy 10 ounces of silver even with your total cash balance, however, you decided to buy 2 for $200, after some time the price increased to $200 per ounce as earlier envisaged by you, then you have made extra $200 which will now sum your total balance to $1200 when you close you deal or trade. But with a leveraged account say 1:2 (which means you have times 2 of your total cash balance to trade with), you will only need 10% of your total cash balance in other to acquire the same amount of silver when the price was $100.

The apparent advantage of using leverage is that you can make a considerable amount of money with only a limited amount of capital. The problem however is that you can also lose a considerable amount of money trading with leverage. It all depends on how wisely you use it and how conservative your risk management is.

Hedging with forex is a strategy used to protect one’s position in a currency pair from an adverse move. It is typically a form of short-term protection when a trader is concerned about news or an event triggering volatility in currency markets. This can be done by counteracting their market exposure with an opposite position in a very similar market. A forex trader can create a “hedge” to fully protect an existing position from an undesirable move in the currency pair by holding both a short (sell) and a long (buy) position simultaneously on the same currency pair.

1. An investor can have both short and long exposure
2. An investor can take advantage of Leverage
3. An investor can hedge