A contract for difference (CFD) is a financial instrument that allows traders to speculate on the price movements of various assets without actually owning the underlying asset.
When you trade CFDs, you enter into an agreement with AvaTrade to exchange the difference in the underlying asset’s price between the time you open the trade and the time you close it.
One of the key features of CFDs is their flexibility. Unlike traditional investments, CFDs generally have no expiration date, allowing you to hold your trades for as long as you like. Furthermore, in some countries, CFDs are often exempt from stamp duty, reducing overall transaction costs.
Another advantage of CFDs is the ability to buy or sell the asset. This means you can potentially profit from both upward and downward price movements, depending on your market expectations.
CFDs also provide access to a wide range of markets, including stocks, indices, commodities, forex, and cryptocurrencies, offering great diversification opportunities.
As we progress through this guide, we’ll explore the intricacies of CFD trading, including leverage, benefits, risks, practical examples, and risk management strategies.
Ultimately, you’ll have a comprehensive understanding of CFD trading and the tools needed to navigate this dynamic market.
Which instruments can be traded as CFDs?
CFDs offer a wide range of tradable instruments, allowing you to access different financial markets. With AvaTrade, you can trade CFDs on popular assets such as stocks, indices, commodities, foreign exchange (Forex), ETFs, and cryptocurrencies. This diverse selection allows you to explore different markets and take advantage of diverse opportunities.
Buy or Sell
One of the main advantages of CFDs is the ability to go long or short on an asset. Going long means buying a CFD in the hope that its price will rise, allowing you to profit from upward price movements.
Conversely, short selling involves selling a CFD in the hope that its price will fall, allowing you to profit from downward price movements.
This flexibility allows you to profit from both rising and falling markets.
CFD Margin and Leverage
CFD trading often involves the use of leverage and margin.
Leverage – allows you to control a larger position with a smaller initial investment. This is achieved by borrowing money from your broker. With 10:1 leverage, traders can control a $10,000 position using only $1,000 of their own money.
Margin – Margin is essentially the amount of money a trader uses to control a leveraged position. Deposit margin (initial margin) is the initial capital required to open a position ($1,000 in the previous example), while maintenance margin is the minimum account balance required to maintain the position. If the account balance falls below the maintenance margin, a margin call is issued, requiring the investor to add funds or sell their securities.
CFD Trading Costs
When trading CFDs, you should be aware of the fee structure associated with your transactions. The two basic fees are the spread fee and the overnight fee.
The spread refers to the difference between the buy and sell prices of CFDs and serves as compensation to the broker.
An overnight fee, also known as a swap fee or rollover fee, may apply when you hold CFD positions overnight. This fee is associated with the cost of maintaining leveraged positions after the market closes and can be affected by factors such as interest rates and market conditions.
Determining Profits and Losses in CFD Trading
Profits and losses in CFD trading are determined by the difference between the opening and closing prices of your trades. If the market moves in your favor, you can make a profit. Conversely, if the market moves against your position, you risk incurring a loss. It’s important to note that losses can exceed your initial investment, which underscores the importance of risk management strategies.
Hedging with CFDs
CFDs offer the opportunity to implement hedging strategies to manage risks or offset potential losses. There are two aspects to consider:
Hedging physical market exposure through CFDs: If you already have a physical position in an asset, you can use CFDs to hedge this position. By taking an opposing CFD position, you can offset any adverse price movements in the real market. For example, you have invested your savings in Apple shares. Upcoming news from the company is expected to have a negative impact on the stock price. You can protect yourself against expected losses in your investment portfolio by opening a short CFD position on Apple shares. A short position generates a profit if the price of the underlying asset decreases. This short CFD position will offset losses in the real portfolio.
Hedging one CFD position with another: You can also hedge a CFD position with another associated CFD. For example, if you have a long position on a CFD for a particular stock, you can hedge that position by taking a short position on a CFD for other stocks in the same sector.