What is a CFD? Contract for Difference Explained.

What is a contract for difference (CFD)?

A CFD, or contract-for-difference, is a financial derivative that allows traders to profit from price movements, rather than actually owning an asset. 

It is essentially a bet on a particular asset going up or down in value, with the CFD provider and you agreeing that whoever wins the bet will pay the other the difference (between the asset’s price when you enter the trade and its price when you exit the trade).

In forex terms, A CFD is an agreement to exchange the difference in the price of a currency pair from when you open your position versus when you close it.

Trading forex CFD gives you the chance to trade a currency pair in both directions. You can take both long and short positions.

If the market moves in the direction you predicted, you profit from the price difference. If the market goes against you, you would make a loss.

In practical terms, if you buy a CFD at $50 then sell it at $51, you will receive the $1 difference. Conversely, if you went short on the trade and sold at $50 before buying back at $51, you would pay the $1 difference.

Fun Fact: CFDs were originally traded among financial institutions, such as banks. But in recent years, they’ve become more popular with retail investors because they allow you to trade without having to own any securities yourself.

Markets you can trade with CFDs…

CFDs offer the opportunity to trade a vast array of financial markets, including stock, index, shares, treasury, currency, commodity, cryptocurrencies, and more…

CFDs don’t have an expiry date. A contract for difference is renewed at the close of each trading day and traders can keep their position open indefinitely.

Well, for as long as there’s enough margin in their account to support the position. 

There are also a very few fees charged for trading a CFD (other than the overnight fee), and many brokers don’t charge any commission or fees when entering or exiting a trade. Instead, the broker makes money by having the trader pay the spread. To buy, a trader pays the ask price, and to sell/short, the trader must take the bid price.

CFD MARKETS

Price Factors

Factors that affect price movement in CFD trading depend on the markets in which the asset is part of. 

For example, crude oil CFD prices are mainly driven by supply and demand or by seasonality. 

Prices of equity CFDs can be determined by business factors or company-specific factors, such as earnings or acquisitions.

Price movements in the forex market are mostly influenced by fundamental factors, such as economic growth, inflation, interest rates, geopolitical tension, monetary policy expectations and environmental factors.

A CFD trading example

Let’s paint a picture. 

Trump has been busy on Twitter, the jobs market in the US appears to be stalling and you expect the level of Non-farm Payrolls to come in below analyst’s estimates.

Surely this means the US dollar will weaken and the British pound will strengthen… Time to go long (buy) 1 CFD on GBP/USD at 1.3100.

Good news, non-farm Payrolls came in even weaker than you expected! GBP/USD is now trading at 1.3180 / 1.3182 and you decide to buy to close at 1.3180. 

You bought at 1.3100 and sold at 1.3180, a rise of 80 pits. This gives you a profit of $80.

CFD LONG POSITION

The higher the exchange rate goes when you go long, the more money you’ll get.

You might as well be the smartest trader to have ever lived…

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But what would have happened if the non-farm payroll data had come in better than you expected?

CFD SHORT POSITION

If the US dollar would have strengthened against the pound, sending GBP/ USD lower and you decided to close at 1.3050, you would have lost $50.

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Remember, all forms of trading involve risk. And dealing with derivatives can be even trickier for newbie traders. 

The smart thing to do is to take your time. You’re on your way to expanding your trading basket and your trading skill set. 

Don’t rush things and make sure you complete our trading academy before you start placing any trades.