Traders often use CFD contracts to expand trading instruments. They provide an opportunity to make a profit during ascending and descending trends. Let's talk about what CFD contracts are and what you need to know in order to use them correctly and make a profit.
CFD contract: what is the point
A CFD contract is an agreement between two parties (the seller and the buyer) on the transfer of the difference between the prices of the asset when the transaction is opened and at the time of its closing. Such a derivative instrument is often used by traders.
Using CFD, it is possible to fully trade different assets at the same time - shares, indices, currency, including digital. But the stock market significantly benefits from the use of such contracts, since the trends on it persist longer, and when the reports are released, the securities of different issuers show a significant movement.
Features of CFD contracts
CFD is an abbreviation of Contract For Difference. It makes it possible to trade not in the financial instrument itself, but in its price. Such trading is speculation on the price movement in any direction. At the same time, the trader receives all the benefits inherent in trading shares without actually owning them.
Such a contract follows changes in asset quotes and is concluded for a short period. Its purchase does not imply dividend payments. In addition, transactions are made only between the broker and the trader.
CFDs were created in order to satisfy the requests of stock speculators with a small deposit, since for operations with them it is necessary to deposit only a part of the funds from the price of the underlying asset. This type of trading is called margin trading, that is, with the use of leverage. Such contracts increase the number of participants, providing access to the market even to traders with little capital.
The principle of CFD operation
CFD trading is the execution of trading operations for the purchase and sale of stock and currency market assets. We explain how it works. When, for example, a trader makes a forecast that the shares of a certain company should rise in price from $500 to $600, he can open a purchase transaction at the current price and close it when it reaches the expected mark. Trading CFD contracts in such a situation does not have significant differences and is not more complicated than trading real securities. It is possible to make a profit by increasing quotations.
Let's also consider the situation when a market participant assumes that the price of shares will start to fall. Then it is impossible to sell them according to the classic scheme, so it is worth using a CFD contract for a decrease. For example, a trader assumes that the price of the company's shares will decrease from $500 to $400. If the forecast is correct, you can make money on a downward trend. For this purpose, they open a short CFD position on the company's asset at a price of $500 and set the take profit at $400.
How CFD trading works
We have already understood what CFDs are, and we have clarified that it is possible to make money on them by choosing one of two tactics. Let's consider them in more detail.
Trading on increasing quotations
When forecasting an increase in the value of assets, the trader trades in stages:
Defines the cost level. For this, different types of analysis are used — fundamental, technical, graphic, price action, and others, including non-traditional methods.
Checks the possibility of entering the market. Sometimes a trader may not start trading. For example, when there is a threat that the "correct" Stop Loss level will provoke losses that are unacceptable for a market participant. He can also not open an order if the damage at the stop-loss level exceeds the potential income at the take profit.
Opens a purchase order (BUY). When the trader has checked everything and has no doubts, he can enter the market.
With this type of trading, the success of transactions largely depends on the experience of the market participant.
Trading at reduced quotes
Trading with the prediction of a decrease in the price of assets is carried out in the following stages:
Choose levels for entering and exiting the market. The same methods of analysis are used in such trading as in bullish trading.
A sale order is opened.
They periodically analyze the situation and, if deemed necessary, change the stop-loss and take-profit levels.
When fluctuations are observed on the stock exchange and, according to the trader, the asset has reached its potential, he can close it manually. The market participant also has the opportunity to move the Stop Loss to a break-even area or to a position with a low income, if the price of the selected asset is in the profitable zone. When it is impossible to do this manually, you can activate the trailing stop loss. It is set automatically at the required level from the current price.
CFD trading should be done only through a reliable broker. It is worth checking whether the company has a valid license and whether it provides access to various trading platforms.
Advantages of CFD
Among the advantages of trading with the use of CFD contracts, it is worth highlighting:
Ability to open transactions in any direction. A trader buys or sells CFDs. It all depends on his opinion regarding the price increase or decrease. Accordingly, a long or short position is opened. It is possible to make a profit even with a decrease in cost.
No hidden commissions. Usually, the broker provides all the conditions of CFD trading. They are transparent and do not contain a trick. You can find them on the website of the brokerage company.
Absence of actual ownership of assets. When, for example, a CFD contract for precious metal or oil was purchased, they will not be transferred to a market participant and, accordingly, it will not be necessary to organize their storage.
The possibility of opening transactions that exceed the trader's capacity in terms of volume. This becomes possible thanks to the provision of leverage by the broker.
Expansion of the number of assets through a single account. Innovative platforms make it possible to manage active transactions using one trading terminal, which makes trading easier and faster. This is also a good opportunity for comprehensive analysis of quotation dynamics.
Ability to increase potential income thanks to credit funds provided by the broker. With their help, you can open more orders for a larger volume. This gives an opportunity to generate a higher profit.
CFDs are also suitable for hedging. For example, if an investor previously purchased the issuer's shares and predicts that their value will soon fall, then the damage from the alleged losses can be smoothed out by applying contracts for difference. That is, a trader can make money on a short-term downward momentum by selling or buying the equivalent value of securities.
Risks and disadvantages of CFDs
A contract for difference is a complex instrument. Trading with its use is always associated with risk, for this reason it is important to carefully understand what CFD is and what are the principles of its operation. Every decision should be well thought out. It is also important to clarify for yourself whether you are ready to lose money.
When using contracts for difference, you may encounter various risks:
Large leverage. An increase in potential profit thanks to the loan increases the probability of the deposit being merged. In order to reduce this risk, a trader can use standard principles of capital management or create his own. If in the first case the risk should not exceed 2% of the deposit, then in the second case the trader can reduce it to 1% or increase it to 3% at his discretion.
High volatility. Such a situation carries an increased risk, in particular, when using a large leverage. Fluctuation of the asset is a natural phenomenon. The ATR indicator is used to determine volatility at different time intervals. It is also possible to minimize the risk by using capital management principles or using hedging methods.
Speculative properties of contracts. The tool is used for speculation with assets without actual ownership. But it is worth considering that it is not always possible to get an income in trading.
A trader can choose tools for trading depending on the situation. In some cases, it is better to use CFD contracts, in others - shares, currency, etc.
We wish you successful trading with ArtCap !
