Contracts of Difference are a dynamic substitute to conventional trading. The concept and theory of CFD trading is elementary. When trading CFDs all an investor needs is to look at the market trend. If he thinks that the market is set to rise, an investor can opt to buy at the top end of a quote which is normally referred to as the offer price. When the investor thinks that the market is set to fall, he can buy at the bottom price or the bid price. All that is required in CFD trading therefore is a keen understanding of the market trends and maybe some professional advice would also not hurt. Because an investor never actually owns the instrument he is trading on, his position is the contract when it comes to contract of difference trading. The most important fact an investor needs to understand is that when he buys he wants the prices to go up, and when he sells, he wants the prices to go down or drop. This is the key principle in CFD trading.
CFD trading involves leveraging your money. Rather than having to raise the whole price for an asset, an investor can trade with the same asset for a fraction of the price. Through CFD an investor can control and benefit from the rise in value of a share, currency and other financial instruments. CFDs provide an avenue to speculate and place bets on the future of assets without having to own the actual asset. CFD trading has a high potential for much larger profits than regular trading as the amount of money one needs to have to take out a position is not normally more that 10% of the actual value of the asset.
Below you will see a typical CFD trading. It will demonstrate when to take out a position as well as when to liquidate a position. The example was taken from a CFD provider and it is not a representation of an actual trade.
It’s March 2011 and Westpac is quoted in the market at $26. You decide to buy 1,000 shares as a CFD at $26, the offer price. Your initial outlay is just 5% x 1,000 shares x $26 = $1,300.
A week later, Westpac has climbed to $27 or $28 in the market and you decide to take your profit. You sell 1,000 shares at $28, which is the closing level price. The commission on this transaction is assumed to be 0.3% of $28 (1,000 shares x $28 x 0.3%).
Your gross profit on the trade is calculated as follows:
Closing level $28
Opening level $26
Profit: $2 x 1000 = $2000
An investor should also take into account that CFD trading is a highly geared investment strategy that carries a high risk to his or her capital. This being the case an investor should only trade with money that he can afford to lose. CFDs are a leveraged product, and this means that there are some inherent risks that come with them.