CFD trading

How Does CFD Work?

When you go into trading, you will discover that there are different ways that you can trade. One of these ways is CFD trading. This is a form of derivative trading that has grown in popularity over time. Choosing to trade a CFD means that you are choosing to go into a contract so that you are able to exchange the difference in price of an asset. This will be from the time that your position opened until the time that it closed.

It is worth noting that you will not be buying or selling an underlying asset as you would with traditional trading. With CFD, you will be looking at buying or selling a certain number of units based on what you think will happen with the price movement. The instruments you will find when CFD trading include shares, currency pairs, stock indices, treasuries and commodities.

For this to work effectively, there are some concepts that you need to be familiar with as follows: –

Going Long

This is the description that is used when you believe that the price will go up so you choose to enter a contract. Basically, a rise in the price will result in a profit. The CFD should open and close on the same day when you are buying it. If it does not, then you will have to pay a daily financing charge in addition to the commission that is charged for the transaction.

Going Short

This is almost the opposite of going long. In this case, if you believe that the price is going to fall, then you go into a contract for this. In this case, you will make a profit in the event that the price falls though you will experience a loss if the price were to rise. In the event that the CFD does not open or close on the same day, then you will receive a credit in your account. The commission still applies for these types of transactions.

Duration

There is typically no fixed expiry for a CFD trade. When you place a trade in the opposite direction to the way that you opened it, then the position of that trade is closed. When you decide to keep a CFD position open once trading has ended, then you will be subject to an overnight funding charge. The only exception to this would be a forward contract as it will have an expiry date and the overnight charges will have been included in the spread.

Spread and Commission

Looking at the way CFD prices are quoted, you will note that there is a buy price and a sell price. The sell prices are normally lower than the current market price, with the buy prices being higher. It is the difference between the two that is known as the spread. There is a commission charge that CFD trades will incur. This arises when the trade is opened as well as when the trade is closed.

There are some key reasons that you may want to consider CFD trading for making your profits on various commodities. To begin with, it is possible to trade on margin. This means that you can go long or go short depending on what you believe will happen with the price. Furthermore, there is the benefit of not needing to pay any stamp duty when trading CFDs which means that they are tax efficient. CFDs are margin traded making it possible for you to take a larger position that you would with normal equities. This means that you can get a better return on investment.

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