Whilst CFD trading is an increasingly popular trading vehicle, it’s also commonly misunderstood and deceptively complex to master.
This is why between 74% and 89% of retail investor accounts lose money when trading CFDs, as individuals struggle to comprehend their true complexity when analyzing the market and executing orders.
In this post, we’ll explain CFD trading in a little more detail, whilst asking precisely how this investment vehicle works.
What’s CFD Trading?
In simple terms, CFD trading is defined as the buying and selling of contracts for difference. These contracts are derivative products rather than fixed assets, as they enable you to speculate on a variety of financial markets without assuming ownership of the underlying financial instrument.
This offers an insight into the key benefits of CFD trading, as you invest in everything from forex and shares to indices and commodities whilst also leveraging opportunities to profit in a depreciating market.
When you trade a CFD through an online brokerage site such as ATFX, you’re agreeing to exchange the difference in the price of an underlying asset from when your position is opened to the moment that it’s closed.
The derivative and margin-based nature of CFD trading also lends offers tremendous leverage to investors, who can gain significant exposure to a large position without having to cover the full cost at the outset.
More specifically, you can make a relatively small deposit to open the position, before ‘borrowing’ the remaining capital from your chosen brokerage site.
This way, you can spread your own capital further and potentially maintain a large number of open positions at any given time.
How Does CFD Trading Work?
Now that you have a basic understanding of CFD trading, the next step is to determine precisely how this investment vehicle works.
The first step involves the spread and commission associated with your trades, with CFD prices quoted in two prices; namely the ‘buy’ and ‘sell’ price. The sell (or bid) price refers to the value at which you open a short CFD, whereas the buy (or offer) price details the value at which you’re able to open a long CFD.
You’ll notice at this stage that these prices are slightly exaggerated, with the selling price slightly lower than the real-time market value and buy price marginally higher. The difference between these two entities is the spread, and this will have a significant bearing on your eventual profit or loss.
The size of CFD orders will vary depending on the value and nature of the underlying asset, whilst they also tend to mimic the market that they’re affiliated with. More specifically, share CFDs will replicate the stock market, and it’s important to keep this in mind when executing orders.
It’s also interesting to note that most CFDs have no fixed expiry, and this factor sets them apart from spread bets and options.
Instead, a position is closed by placing a trade in the opposite direction to the one that opened it, although CFDs that remain open past the daily cut-off time (which is usually 10 pm GMT) will incur an overnight funding charge.