CFD trading is when you buy and sell CFDs. CFD stands for the contract for difference. These are derivative products as they enable you to speculate on financial markets. These financial markets are FOREX, indices, shares, and commodities. You do not have to take ownership of any of the underlying assets.
Instead of owning, when you trade CFD, you agree to exchange the difference in an asset's price from the point at which the contract is open to the point it closes.
One of the largest benefits of CFT trading is speculating on price movement in either direction. And the profit or loss that you make is dependent on the extent to which your forecast is correct.
If you think that IBM shares are going to fall in price, you could sell share CFDs on the company. You will exchange the difference in price between open and close but will earn a profit if the shares drop in price. You would have a loss if they were to increase in price.
How Do CFDs Work?
There are four concepts that you need to understand about CFD trading.
Spreads and Commission
CFD prices are given at two prices—the price you will buy at and the selling price.
- The buy price, or the offer price, is the price that you can open a long CFD
- The sell price is the price that you can open a short CFD
The sell price is going to be slightly lower than the current market price. The buy price will be slightly higher. The price difference between the two is what we call the ‘spread.’
CFDs are traded as standardized contracts (lots). An individual content size will vary depending on the underlying asset that is being traded. It often mimics how the asset is traded on the market.
Unlike options, most CFD trades don’t have a fixed expiry. Instead, a position is close when a trade is placed in the opposite direction to the one that opened it. For example, a buy position of 500 silver contracts would close by selling 500 silver contracts.
If you were to keep a daily CFD position open beyond the daily cut-off, which is 10 pm in the UK, but might differ on international markets, you would be charged an overnight funding charge. This cost reflects the cost of the capital your provider has, in effect, lent you, in order to open a leveraged trade.
The main exception to this is a forward contract. The forward contract does have an expiry date and has all overnight funding charges already included in the spread.
Profit and Loss
In order to calculate the profit or loss and from a CFD trade you multiply the deal size of the position, which is a total number of contracts, by the value with each contract, expressed per point of movement. You will then multiply that figure by the difference in points between The price when you opened the contract and when you closed it.