CFD Trading Explained

CFD Explained

There are a lot of different ways for people to trade, invest and make a profit. There are more traditional forms like conventional stock trading that are all about buying low and selling high with company shares. Then there are the newer forms of trade, like binary options trading that are more about speculating on asset performance rather than actual ownership. And of course, there are different things to invest and trade in such as company shares, actual commodities like gold or oil, and even currencies.

For people that are just beginning to their journeys in trading and investment, binary options trading may be the gentlest introduction into this world, but there are others. One, known as CFD, is a very exciting, even unpredictable form of trading with a lot of potential for big wins, with some similarity to binary options trading, and some very big differences too.

Let’s see what they are.

Derivatives & You

CFD is just the abbreviation for the a form of trading known as “Contracts For Difference.” Unfortunately, even having the full name laid out like that isn’t especially instructive without more explanation about the workings of some trades. A CFD is a type of trade that speculates on where an asset’s price is going to go. The trader makes a prediction about that price, the broker accepts it, and the difference from your prediction to the final result is what you get paid.

If we go by a very simple example, we’ll look at the stock market. A clothing company has just gone public with its stocks and a trader would like to make CFD trades with this company’s stock. The trader makes a prediction about the stock price, which is currently trading at $15 a share, and says that the price is going to rise by $10 more. Things go very well however, and the price on stock goes up a bit more, to $40 in value during the trading period that the CFD was made.

Now, because the final stock price went far above the trader’s prediction, the broker must pay the “difference” on the amounts. Since the trader initially made a CFD at $25, any closing price above the $25 mark will have that increase paid to the trader. Because in this example the trading closed at $40, this means that there’s a $15 difference that is paid out to the trader.

However, this goes both ways. If you make a successful CFD trade, you get paid the difference between your prediction and final result. But, if you make a bad CFD trade, you pay the difference. So if, in our previous example, the trader made a CFD trade for $25 while the stock was sitting at $15, and then the price dropped $10 more to $5, then the trader would now owe that difference to the broker and would have to pay it out.

In one sense, a CFD is identical to a binary option trade in that you are not buying an actual stock, commodity or currency. Instead, you are speculating on the performance, so regardless of whether the asset does well or poorly, as long as that performance is in line with your prediction, money is made. But there are some big differences as well, and these are what will separate those that prefer binary options trades from CFDs.

More Reward, Less Stability

One of the biggest differentiators between binary options trading and CFDs is the way in which profit is made. Binary options trading has fixed values, meaning that once you decide to make a trade, the amount of profit you can make or lose is “locked in,” you know exactly what you’re getting into. This means that there are no surprises in terms of profit or loss. CFDs pay out their results based solely on what the final performance is, regardless of whether you are financially prepared or not.

This means that in event the price does better than you predicted, you can actually make a lot more money than you’d estimated. Conversely, it also means that when you lose, you may lose more than you are prepared to pay. CFD traders, for example, that traded the wrong way during the Brexit announcement and watched the value of the Sterling pound drop, suffered huge financial losses during that day, when everyone was sure that Brexit wasn’t going to happen and that the currency would rise once the referendum results to stay in the European Union came in.

Another thing to keep in mind is that for American traders, CFDs are strictly off limits. The American government does not approve of CFD trading, and will not allow brokers to offer the service to American citizens. People in other countries, like Canada, for example, are fine. But the important thing to keep in mind is that while the basic speculation principles of a binary options trading and CFDs are similar, the mechanics of profit will sharply divide preferences.

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CFD Trading Explained
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