CFD trading: know the basics
All stocks and BitCoin are traded as CFDs and are executed at the below listed times.
Over the past decade CFDs have become the most popular way for online investors to trade stocks, commodities, indices and currencies.
But have you ever asked yourself what this mysterious abbreviation actually stands for? And what does it mean for your investment activity?
There is a lot of myth and disinformation surrounding CFDs, so here we will go back to the basics to explain what a CFD is and what are its implications for investors such as yourself.
What is a CFD?
CFD stands for “Contract For Difference”. To put it simply, a CFD is an agreement between yourself and a broker to pay each other the difference between the price of an asset (such as Gold, EUR/USD, Microsoft stock, etc.) at the moment the contract is made and its later price when you decide to terminate the contract, i.e. close the trade.
Sounds complicated? Well, it’s really not. All it means is that you’re investing in the possibility of the price of an asset moving up or down, instead of buying an actual asset and hoping for its price to go up.
How does it work?
The logic behind trading CFDs is pretty much the same as investing in any other market, like stock for example. If the price of the stock goes up by 10%, your investment does the same. If, on the other hand, the price of the stock goes down by 10%, your investment also loses 10% in value.
Say you’ve decided to invest in a $100 CFD on Apple stock. If the stock price went up by 10%, your contract would go up by 10% as well, so if you decided to close it at that point you would take a profit of $10, meaning $110 in total.
Can I only make profits when prices are going up?
No. One of the big advantages of investing in CFDs rather than in markets like commodities or stocks, is that you can profit from falling markets as well. Remember, a CFD is a Contract For Difference, but that difference can go in any direction. So you can invest in the possibility of prices going up or down, according to what you think is likely to happen.
The stock I want costs a $1000 per share…is that the minimum amount I have to invest?
No. CFDs make it possible to invest smaller amounts in the markets of your choice. With CFDs you don’t have to actually purchase or own an instrument, so you are not constricted by the high prices of certain stocks or commodities. So even if the price of Google stock, for example, is $1000, you can invest in Google with as little as $10 at eToro! That’s basically one of the greatest advantages of using CFDs.
Are some investments unique to CFDs?
Yes. Indices such as the DJ30 or the SPX500 for example are not actual physical assets – you can’t own a piece of an index. However, with CFDs you can speculate on index performances, which enables you to invest not just in one stock but in whole sectors of national economies.
Are CFDs riskier than traditional market investments?
No. Any financial investment is risky, and CFDs are no different. CFDs only become riskier if you’re using leverage, thereby increasing your market exposure. However, you can very well trade CFDs without using any leverage, in which case your risk would the same as if you were trading in the markets directly. At eToro for example, you can invest in stock without any leverage, and you can invest in all the other markets we have on offer with leverage as low as 1:2.
Are CFDs necessary for Copy Trading?
Yes. CFDs provide the flexibility that makes it possible to execute copied trades while maintaining precise proportions between the copier’s allocated Copy funds and the copied trader’s account. Without CFDs, if a trader you’re copying with $100 invested a portion of his account in Google stock, for example, you would not be able to copy this trade, since one Google share currently costs over $500.