CFD stands for the contract of difference. As the name implies, it is a contract between a buyer and a seller; it requires the buyer to pay a calculated difference between the present value of a financial property or an asset and its value at the time of the making of the contract. CFD trading has become increasingly popular because of its numerous benefits. This trade is brought about by an agreement between the seller and the broker. Furthermore, this contract does not require you to have any forex, stock, or commodity.
CFD trading enables members to profit from price movement without actually owning an asset. Traders earn money by speculating accurately on the value rise or drop of any financial investment. It demands that the buyer pay the seller the price change between the contract entry and exit, which means the difference between an asset’s current value and its value at the contract’s signing. CFD trading South Africa has bloomed over the past several years. It is also expanding globally, notably in New Zealand, Australia, Norway, Hong Kong, India, Sweden, etc.
How does it work?
CFD trading offers both flexibility and diversity. To understand the greys of this type of trading, you will need to understand three key concepts:
- Difference between CFD and owing (and buying or selling) assets
- Leverage to use to boost your buying power
- Risks involved in this type of trading
Owning any asset means you have to invest a certain amount in the stock exchange. It could be the Shanghai stock exchange market or the London stock exchange market. This investment will earn you a certificate. The certificate will be proof of your ownership. So what does ownership get you? This ownership will provide you with some privileges; they could be voting rights or fractional ownership of a firm. It all depends on how many shares you buy.
On the contrary, a CFD works a lot differently. In this kind of trade, you don’t buy or sell shares. You don’t receive any ownership rights. However, a CFD trader makes an agreement with their broker that they will pay the cost of the difference. As mentioned before, this difference will be the price change between current value and value at the time of contract occurrence of an asset. So if the price of the asset goes up, your broker has to pay you. But if the price goes down, it will be you covering the losses.
Next up, we have leverage. Leverage plays an essential role in CFD trading. It is a very beneficial instrument that many traders use to their advantage. It is indispensable to increase one’s buying power. But who sets the conditions of leverage? Since there are two types of leverage: Retail and Professional. Two different authorities set it. Retail leverage is regulated by ESMA (European Securities and Market Authority).
Meanwhile, professional retail depends upon the broker you choose. CFD generally has higher leverage than standard trading. But it is subject to changes too. The lowest CFD leverage was 2%. Presently, it is at 3% or 30:1. There is a possibility it could rise to 50%. But beware that leverage is a precarious concept. You could either exponentially increase your benefits or suffer a humiliating loss. It can also lead you to lose possession of the entire capital.
CFD is a diverse trade. It entertains commodities, crypto, currency pairs, stocks, et cetera. Since CFD, at its heart, is a game of uncertainties. It is a dynamic trade. Traders bet on the rise and drop in prices. These market trends tend to change quite dramatically. Therefore, traders need to keep an eye out for the prevailing circumstances. However, this might not always shield you from losses. Despite the fact that many CFDs traders are protected against loss, one cannot altogether avoid it. Acute pricing change, liquidity jeopardies, margins, disturbance in trade, or market cessation are some of the few factors which may imperil your position.
CFD is an unconventional form of trading that only practised traders employ. Physical goods or commodities are not produced in this sort of trading. A CFD trader does not enjoy the financial product. Yet, he builds revenue based on its value difference. If the trader foresees the price to decline, he has to buy an offsetting trade. Traders do this to close an opening cell position. Ultimately, the net variation of the loss is resolved through cash in their respective accounts.
If a trader finds the cost of his asset increasing, he can put it up for sale. The sheer difference between the sale and original prices profits together and the gains are paid by the brokerage’s account.
CFD trading may have a certain charm thanks to its immense perks. Nevertheless, it can lead to heavy gravitating losses too. Hence the purpose ESMA limits this kind of trading. Such measures are exercised to guard customers against exploitation.