CFD is a contract or agreement between a broker and a trader that works on the opening and closing price of the shares. The word CFD stands for “Contract for Difference”. The basic idea of CFD trading is making profit from changes in the price of stocks and shares.
Let’s take an example to understand the concept more clearly. Let’s say you bought CFD on a stock that is $5.00 and then the price rises to $5.50. If you sell the CFDs now, you will be making a profit worth of $500 minus the costs. You can also go for short selling of CFDs and make profits while the market is falling.
CFD trading is done on leverage, which is why it has become such a popular trading product. Usually the leverage is about 10:1. However, some providers come up with 20:1. This means through this kind of trading, you can make larger profits with smaller float. However, the trading results are overstated. So if your system is making a certain amount of loss in a year without any leverage then this will be multiplied when you are using leverage.
Advantages of CFD Trading
There are quite a few advantages in choosing to start CFD trading. Among the advantages, you have access to leverage of your Contracts For Difference trading account, allows easy access to short trades to avail you to more opportunities and also features the usage of stop losses gives you options to protect your trading capital.
CFD’s Mean Leverage
Leverage boosts the profitability of CFD trading up to 20 fold. For instance, in case of 10: 1 leverage, a trader can buy CFDs worth of up to $50,000 with a fund of $5000. Now, if you are trading with a system that generates a certain amount of profit without using leverage then with leverage you will generate a return that is magnified.
CFD Trading Allows for Trading Long and Short
While doing CFD trading, you can go for both long and short trading. How much you will be able to short the CFDs depends on the broker. Some CFD trading brokers will allow you to short a major portion of the CFDs that they will provide on the other hand some will allow you to short a smaller portion. Since in case of short trading you can make profit from both rising and falling stock prices, this trading approach can boost up your profitability significantly with some trading systems. So you can make profit from both bull and bear market.
You can Trade Shorter Time Frames
In case of CFD trading, you can make money from smaller moves in the underlying stock prices due to the opportunity to short CFDs and because of the availability of leverage. You don’t need to hold your positions for a longer period of time to make profit from your trades. For instance, you don’t need to hold onto some stocks for months in order to make profit from trading but instead you can trade systems even when you are in trading for only a few days or weeks. This is why you will notice a smoother and more consistent growth equity curve for your trades.
Usage of Automatic Stop Loss
Another great advantage of CFD trading is it allows you to place automatic stop losses on your trading platforms something that is not available in case of stocks. The main advantages of this particular option are:
First of all this will allow you to close a trade automatically “intraday” rather than looking at the end of the day to find whether the price of the stocks has exceeded your stop loss, before exiting the following day. This helps the system to generate more profit by allowing you to avoid the slippage. Secondly, using automatic stop losses makes it a lot easier for a trader to use a mechanical system since the exit is done automatically. This again will increase your profitability if you are dealing with a profitable trading system.
This kind of trading allows a person to execute trades even in the evening. It is almost impossible for people to place trades and exit them in the day time if they are attending to their work place throughout the day. Some CFD providers will provide you the opportunity to place trades in anytime of the day and night. So in the evening when the market is closed, you can still place an order to enter CFD and “if done” stop loss order as well, all at a time. And you don’t even have to keep your eyes on the pc throughout the day for trading. The whole trading routine will take much lesser time.