- Category: Articles
- Published on Sunday, 10 June 2012 07:21
- Written by Super User
- Hits: 11732
For a few years now, investors and traders have acces to an exiting new tool: the CFD, which is short for: Contract For Difference. In a relativly short time, trading cfd's has become more and more popular and most forex brokers now also offer the possibility of cfd trading. But what really is a cfd and what are the best brokers to trade it with? In this article i will try to anwser these questions.
What is a CFD?
CFD's or Contracts For Difference are investment-/trading- instruments with which an investor can simply anticipate on a rise or fall of the underlying asset. The underlying asset is usually a stock, commodity, index or currency. The cfd is, just like options and futeres, a leverage product.
With a cfd the investor takes on a contract with the broker. He speculates on an up or down move of the underlying asset. The contract doesn't have an end date. The investor can close the contract after a few seconds or let it run for years, dependant on his investment goals. Usualy though, cfd's are used for the somewhat shorter trades.
How trading a cfd works is best made visible by looking at an example.
The investor opens a cfd long with as underlying asset, one ounce of gold. The purchase of one ounce of gold in an ETF would cost the investor $1600. To open the cfd, the investor only needs to have a certain amount of cash on his account as margin. Let's say the margin percentage in this case is 10%. The investor needs 10% of $1600 = $160 in his account.
Now say gold rises in value to $1760. The investor in the gold ETF made a profit of $160. His investment was $1600, so he made a 10% profit.
The cfd investor receives the difference in price of 1 ounce of gold between the moment of opening the cfd and closing it. In this example that is: $1760 - $1600 = $160. The profit for this investor is also $160. The investment (margin) of this investor was $160, so he made a profit of 100%. The leverage of this cfd was 100%/10% = 10.
The investor in cfd's is never in posession of the underlying asset. The broker buys the underlying asset on the financial markets or he hedges it some other way. For this the broker receives a small interest payment from the investor. When the investor takes a short position, than he receives the interest payment.
A Contract For Difference can not be traded on any stockexchange. The investor always has the broker as counterparty. This means that the cfd investor can lose all of his money is the cfd broker goes bankrupt.
There is a good number of cfd brokers to choose from. It is worth the effort to compare the brokers on rates and offered services. With many brokers it is possible to, without any obligations, open a free demo-account. The demo-account gives you the possibility to practice trading cfd's. You can also try out the offered services of the broker and get familiar with it's trading platform.
The following brokers offer cfd trading:
* your capital may be at risk
What are the possibilities of cfd trading?
The cdf offers the investor a lot of new possibilities. It is now possible to trade a number of assets almost 24 hours a day. You are no longer restrained by the opening and closing time of the exchange. This is mainly with cfd's on commodities and forex a big advantage. These assets are traded on different exchanges around the world, 24 hours a day.
For example: Say you want to profit from a rising oil price, but you don't want to pay more than $100 per barrel. The oil price is moving around $105 per barrel and during opening hours of your local echange, it isn't coming down to below $100. At night, during the trade at the far side of the globe, the oil price quiqly drops to $99 per barrel. A minute later, as fast as it came down, it goes up again. By giving a limited buy order, you can maximize your chances of buying at the wanted price, while you are sleeping in your bed. The same goes for stop-loss orders. They can also be executed almost 24 hours a day.
The number of assets that can be traded is large with most brokers. Usually it consists of a number of forex pairs, commodities, indices and hundreds to thousends of stocks.
Cfd's are a cheap and very flexible new trading instrument. They can be used for short trades but also for medium and longer term speculation. Just like options and futures they can be used to hedge a stock or commodity position. Try it out yourself and see what it can do for you!