A Short Essay on CFD Trading

A Short Essay on CFD Trading

1 June 2016, 16:29
bsadamsmith
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CFD Trading has been quite popular for some time now. Also known by the term “commodities trading”, it signifies the action of a trader realizing the value of the difference between the starting and final price of a certain amount of commodity. The full form for CFD is “Contract for Difference”. This is an instrument which can be employed to understand well the factors which causes movement in the price of a particular commodity. There is no restriction regarding the nature of the commodity traded; it could be anything from gold, silver, oil to cereal grains. There might be a bit of confusion here, so let’s clear it up: None of the assets or “commodities” are actually owned or traded by the person engaged in CFD trading. It is only the difference in the price movements of a certain amount of a particular asset that is bid upon. It is in essence, a bit like gambling; the trader “predicts” the exact increase or decrease in price and sets a price accordingly, and if the prediction bears fruit, then the broker pays the balance (difference between the start and end pricing) to the trader. If the reverse happens, then the trader suffers a loss, and sometimes end up making up for the losses from his own pocket. Let us illustrate an example:

In case the stock has a price of EUR 30 and 30 shares are bought, then the total cost would come to €900. If the trader is working with a broker who uses a traditional margin of, say, 50%, then the cash payable for the trader would amount to €450. However, if one decides to trade with a CFD broker, then the amount of margin that s/he (trader) would be able to avail of, is very large, even up to 5%. Therefore, in the case of this particular example, a trader would only have to expend money worth €180. (Example from the site easyMarkets)

There’s however, one thing that needs to be noted. When one enters a CFD trade and takes a trading position, then one would see that there is a loss which is equal to the size of a the spread difference between the start and end prices. As a result, the price would need to appreciate to a level which is equal to and (if possible) higher than the spread amount, in order for the trader to be at a place where they can anticipate a profit. If suppose, the trader had bought the amount in the manner of a stock, they would have had seen a gain, but they still would have paid a commission and seen a much larger capital outlay.  When you trade through CFD, you get to gain for while spending less. That’s the difference. All in all, one gets to gain more while spending less. And that is without mentioning the fact that Contract for Difference brokers provide people with much higher leverage as compared to more traditional trading methods such as forex trading or stock trading. 

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