CFD or Contract for Difference is a financial instrument used to make a profit on the price change of an asset without having to own it. In other words, CFD is a two-party agreement to exchange the difference between the buy and sell price of a particular asset.
The CFD trader doesn’t have to buy a particular stock, index or commodity to sell it more expensive in the future. Instead, he performs the operation based on his judgment that the value of the asset will rise or fall. If the trader correctly predicts the outcome of a trade, the seller pays the difference between the price of the asset at the start and end of the deal. On the other hand, if he misses the forecast and the asset moves in the opposite direction, the trader is expected to pay this difference.
Contrary to stock and futures transactions, where the broker is simply an intermediary, CFD transactions are always negotiated with the broker's counterparty. Which allows greater agility and quality in the negotiations. This type of operation is called over-the-counter (OTC).
You can trade different assets with CFDs, such as:
• Stocks indexes
• ETFs e ETCs
For example, if the value of a XYZ share is $ 30 at the opening of a contract and $ 31 at the close of the contract, then the difference would be 1. If the investor acquired 1000 CFDs and predicted that the share value would be rise, so the profit made was 1000 x 1 = $ 1,000. That is, he profits from a stock increase without having to buy it.
CFD’s Margin x Asset trading
First we need to understand what margin is.
Starting Margin: This is the minimum account amount to open the position. It is often called a deposit margin or simply deposit.
Maintenance Margin: This is extra money that may be required if the position goes against planed. This margin is required to finance the present value of the open position covering any current losses.
Margin Call: Triggers when investor equity falls below a specified percentage requirement.
To better understand, in the case of XYZ's assets, in order to profit from the same operation in the traditional stock market, the investor should disburse 1,000 shares at $ 30, ie take into account a released balance of $ 30,000. In the case of CFD's the margin required is on average 5% of the value of the transaction, ie, this trader to perform the CFD operation needs to take into account, 5% of US $ 30,000, which is US $ 1,500.
How to measure and leverage CFD's profits?
Continuing in the previous example, if the share price jumped from $ 30 to $ 31 at the end of the period and considering the required margin of each account, the profit from CFDs was 66.6% versus 3.33%. from stocks.
This shows the ability to operate leveraged with this instrument, profiting from larger positions even without taking full value into account.
Another way to utilize the ease of CFDs is by protecting your investment portfolio. If you believe your stock portfolio is going through a period of turmoil, you can minimize this devaluation by operating, for example, in selling S&P 500 CFDs. The great advantage of this protection is that while you are in position, protecting your portfolio and holding the shares, you do not lose the rights to receive any dividends.
Should I invest in CFDs?
CFD trading offers the possibility of a higher profit with a lower investment. On the other hand, both losses and profits can be increased. Therefore this instrument must be carefully operated, and like any other investment, risk control is critical to avoid unwanted damage. Study hard and have a well-defined trading strategy that, coupled with good emotional readiness, can generate above-average returns.