World of finance offers a variety of different options and methods for you to invest your money, CFDs or Contracts for Differences are one of the most commonly preferred of those selections. While stocks, options and forex all offer their own advantages and risks, CFDs stands out with its ability to trade on an asset without assuming ownership of it. Continue reading below to get a more detailed introduction to CFDs and how they are traded.
Contract for Differences
A CFD, simply is an agreement made between two parties, usually a buyer and a broker. These agreements are setup so that the buyer is the one who takes ownership of risk on an asset through the time of the contract, while gaining the ability to get a percentage of the winnings from the original owner of the asset. To put that in more technical terms, a CFD is a contract traded between a client and a broker where the parties exchange responsibilities of losses or gains acquired through the rise or fall of the assets value, from the time the contract is sold, to its expiration.
So, why should you choose CFDs, while stocks and other options might offer greater returns, and actually provide you with ownership of purchased asset. Well, the reason CFDs are so favorable is, ownership requires greater starting capital. With low risk, low starting capital requirements CFDs give people a chance to try their hands in the trade market, without having to make purchases of large assets, but use these contracts to take temporary possession for the sake of gaining profit. If you are a veteran and are comfortable in your trading skills, CFDs also give you the chance to play with other people’s assets and the larger gains those assets might provide.
The Leverage of CFDs
One major advantage that truly makes these short-term contracts so enticing, is the fact that they are leveraged products. As leveraged products, CFDs require you to possess a small portion of the full value of the trade. In other words, with these contracts, your money goes a long way towards the profits you want to make.
You might be wondering, what would a leveraged trade look like compared to the straight-forward method used in most other financial instruments. Here is an example of what exactly leveraged trading in CFDs looks like. Let’s say you chose an asset that is currently valued at $25, for 100 shares, in the regular way of trading you would need to make an investment of $25/share to purchase those shares, but with leveraged trading, you are only required to cover the margin deposit. This margin deposit will differ but for this example we will put it at 10%, so, instead of $2500 you would need to purchase those shares, you will only need 10% of that which is $250. This drives traders to CFDs, the small capital to play with big assets for bigger profits is hard to say no to. To finish our example, during your contracts life span, the value of the asset you purchased increased from $25 to $30. This is a difference of 5p which will get you a profit of $500 on a $250 investment.
One important thing to remember is the risk involved in CFD leveraged trades, while the $500 on $250 seems great, losing $500 after investing $250, leaves a whole different taste in the investors mouth. CFDs are a great tool in the arsenal of the complete trader but it is worth knowing your risks and rewards before jumping in.