Trading in the stock market is probably the first thing that comes to mind when you think of “trading.” Buying stocks, or shares of ownership in a company, allows you to become a shareholder in that corporation. By becoming an existing shareholder, you’re able to hold certain rights, vote on some corporate decisions, benefit from the dividends, and sell your shares to some other potential investor by placing a trade online or finding a broker.
Buying and selling shares of ownership is indeed a traditional way to trade. But do you know you can gain profit from the price movements of fast-moving global financial markets without having to buy and own shares or other assets?
We call it CFD Trading.
CFD Trading Overview
Contract For Difference (CFD) is a popular form of derivative trading. As its name implies, it refers to the contract between you (the investor) and a CFD broker to settle the difference between an opening price and a closing price of an asset. In other words, CFD trading allows you to profit from the falling prices of global financial markets including stocks, indices, commodities, currencies, and treasuries that you’ve taken a position on without owning them.
Stock And CFD: How do they go hand in hand?
A stock is considered as an underlying asset; A contract for difference is a tradable instrument or derivative that mirrors the movements of the asset underlying it.
CFDs are closely related to the buying and selling of stocks. Though the actual underlying asset (like a stock) is never owned, the CFD trader may take profit (or lose money) when the stock moves in relation to the position taken. One stock is usually equals to one CFD.
Trading stocks means you have to purchase them before you can sell them and take profit from that stock’s rising price. For example, you became a shareholder in a renowned company, XYZ Food Corporation by buying 100 shares at $20 asking price for $2000. The asking price you bought the shares for may go up or down depending on many factors which may result in either a profit or a loss on your part. If the stock price drops below your purchase price, you may lose potentially money.
If you believe the general market trend is declining and you’re hesitant about buying and owning stocks, then trading CFDs can be a wise alternative option.
How CFD works
Instead of buying stocks, you could use CFDs to short a particular stock and gain potential profits from a falling market. Given the previous example, your profit or loss would move with the XYZ Food Corporation stock price in the same ways if you owned it. You can also sell a CFD on a stock that you speculate on falling in price and then aim to buy it back later for less to make profit from the difference. If it rises in value, you may potentially lose out.
CFDs are also traded on margin. You only put up a percentage of the trade as collateral based on the requirement set by your CFD provider, which range from 2% to 20%.
Let’s say that the stock has an asking price of $20 and 100 shares are bought at this price so the cost of the transaction is $2000. With a traditional stock broker using a 50% margin, the trade would require at least $1000 cash outlay from you. But if you buy them with a CFD broker on a 5% margin, then you can trade a position on a stock for a cash outlay of only $100.
Author Bio: Sophie Harris is one of the resident writers for FP Markets CFD Trading, a CFD and Forex Trading provider in Australia with over 12 years industry experience serving global clients. Writing informative content about business and finance is her cup of tea.