Contracts for Difference is a financial trading technique that has been used in financial markets for a long time now. It is a derivative instrument that allows traders whether individual or institutional to benefit from assets that they do not own.
To expertly navigate these murky waters of financial trading here are some important factors related to CFD trading.
Understand CFD trading
CFD trading, is a trading technique or contract between the trader and their broker based on an underlying asset. As a trader, you identify an asset that you believe has the potential to make you a handsome profit. You let your broker and decide to take advantage of this believe but without buying the asset.
You spend a percentage of the value of the asset to show interest and to set up the contract with your broker. Once the contract is setup, you can now wait for the price of the asset to move in your favor.
How to profit from CFD trading
Another aspect of CFD trading that you need to understand is how to profit from the contract if you do not own the asset.
When you enter into a CFD trading contract, it is based on the price of the underlying asset. You can enter the contract with a prediction that the price will rise or fall. If the price of the asset prices from your order price, then you have made a profit. If the price falls, you have made a loss.
When you make a profit, your broker will pay you for the current value of the asset. However, the value that you will get paid will be a difference of the money that you already put down. Thus, the name differences in CFD.
On the other hand, if you make a loss, you will have to pay your broker for the difference.
Ability to take a long or short position
In CFD trading with Saxo, you can take either a long or short position or both.
In finance, a long position means a buy. This is the position that you take when you believe that the price of the underlying asset will rise. A short position on the other hand means sell. This is the position you take when you believe that the price of the underlying asset will tank significantly.
You can make a profit regardless of the position you take if the trade goes your way.
Also, you can take both positions at the same time on a particular asset.
Why it is used
Another factor that you need to understand is why a trader may prefer a CFD to any other sort of trade.
First, it does not require you to own the underlying asset. In this case, as a trader you can profit on an asset that you do not own.
Secondly, you do not have to pay the full value of the asset. With CFD trading, the broker will accept 5% of the value of the asset that you are trading.
Third, you can use this strategy to guard against loss of value for an asset that you own. For example, if you had previously bought a particular stock and the current price is lower than the buying price. This means that you are in a loss-making position. With the expectation of the price to fall further, you can take a short position on a CFD trade of the asset. When your expected price is reached, you can then close the trade and make a profit on an asset that is making you a loss.
CFD trading is as risky as forex trading if not riskier. Therefore, as a trader ensure that you are able to handle all the risks that come with it. When you understand how to trade it expertly, this will be your favorite trading skill to use and it will never disappoint.