What is a CFD and How It Works When Leverage Is Applied

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By Kaleem Ullah

What is a CFD? Contract For Difference is a derivative product that is quite popular nowadays. Derivatives are known to be time-limited and they ‘derive’ their value from the asset’s performance in the market. With CFD, you are allowed to speculate in different financial markets such as cryptocurrencies, indices, commodities, forex, and stocks. In between the buyer and the broker is a contract that proves they agree to pay the difference between the opening price and the closing price of an asset. The result can be determined, mostly, at the end of the day.

Defining Contract for Difference

CFD allows you to open a position after paying a part of the overall value of the underlying asset. This is also known as leveraged trading or trading on margin. With this type of trading, traders are allowed to open a larger position with small initial capital. In turn, it gives the trader more exposure to the financial market and the opportunity to gain more profits.

Another benefit of CFD is that traders get to speculate in the market in either direction. You can buy or sell according to your speculation of whether the price goes up or down. You can then open a long position or a short position based on your prediction. But take note, leverage cannot just mirror your wins but also mirrors your loss. Be careful when using it.

Leverage in CFD Trading

What makes CFD popular is leverage. When you trade on the leverage you are only required to put down a small portion of the asset’s value then you will be given the chance to trade a bigger position in the market. Leveraged trading is also referred to as trading on margin. Some brokers will require traders to put down a 10% deposit to open a trading position. The rest of the amount will be covered by the CFD provider.

For example, you are aiming to place a trade worth $1,000 and the broker asks you a 10% margin. In this case, you won’t be paying the actual amount which is $1,000 but the 10% amount only at $100. This initial deposit will allow you to open a trading account and start trading right away.

Understanding Spread and Commission

There are two prices offered to you when you open a trading position. One is the buy price and the other is the selling price. Since you will only be required to pay part of the asset’s value, CFD is known to be cost-effective and flexible. But there are some brokers who are charging for commission on some financial assets while there are others who don’t take commissions when closing or opening a trading account, withdrawals, and also deposits.

But the only common fees that you will have to shoulder in CFD is the spread or the difference of the buying and selling price by the time you start trading. Moreover, for traders who are into long positions, you must consider the overnight fees which might take up some funds when left out for a long time. What is a CFD and how to handle emotions when trading are two important things that need to be properly considered?