Trading CFDs implies, above all, a good knowledge of the financial market. As a financial instrument that relies on the price fluctuations of an asset, it is important for the investor to analyze the market in order to make speculations that will later prove to be profitable. CFD is short for the concept of contracts for difference. Here’s what you need to know about them.

What are CFDs?

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CFDs are financial derivatives that allow investors to speculate on the price movements of an underlying asset. Through them, profits can be obtained even when prices fall.

As long as the markets move in the direction initially assumed, profits are guaranteed. More precisely, a CFD is a contract concluded between two parties. Through it, the one who opens a long or short position registers profits every time the market moves according to his speculations.

How does CFD trading work?

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CFD trading works on a relatively simple principle. At the conclusion of the contract, the difference between the opening and closing prices of a certain financial instrument is exchanged by the contracting parties. It can be stocks, commodities or even currency. Basically, trading CFDs involves:

Contracts for difference can be compared to buying precious metals and reselling them when their price rises. The main difference between this method of making profit and CFDs is that the ownership of the underlying asset is not taken by the investor in the case of CFDs. The difference between the entry price and the closing price is actually the profit or loss, as the case may be, that the trader makes.

The trader who believes that the price of the asset on the basis of which he concludes a CFD will increase, can open a long (buy) position. If the price moves in this direction, the investor will make profits.

On the other hand, a decrease in the price of the respective asset can also be expected. In this case, a short position (sale) is opened and income is obtained only if the price of the good falls during the period covered by the contract. So it is the market return of an asset that determines the recording of profit or loss.

Compared to other trading methods, trading CFDs involves a contract concluded for a short period of time. Additionally, it allows investors to profit from fluctuations in the price of an asset without owning it. They can bet on the rise or fall in the price of the underlying asset, based on the contract concluded with a CFD broker. Thus, it can be said that trading on CFDs is a flexible trading method.

Which are the steps of a CFD investment?

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The first step in CFD trading is a thorough knowledge of this instrument and the risks involved. There are key differences between CFDs and other forms of trading. So a good understanding of how each of these financial instruments works is required.

People interested in CFD trading can take a course at Vestor to understand what CFDs are. They will learn what trading them entails and what the advantages of contracts for difference are. Moreover, using a demo account for familiarization is an effective way to gain experience and be prepared for the first real transactions.

After learning about CFD trading, the next step involves choosing a financial instrument. The investment instrument can be, among others, the price of gold or the shares of a company. A CFD trading strategy requires time to understand and analyze the market so that speculations materialize and generate profits.

Building a trading strategy or plan can be helpful as it addresses the trader’s goals, risk attitude and addresses the topic of available capital.

Further, after choosing the financial instrument in which to invest, speculation follows. Traders who predict that the price of the underlying asset will rise will open a long position. Those who believe that the price of the underlying asset will decrease will open a short position. Afterwards, the transaction volume will be determined. It is important to note that the value of a CFD unit is variable, in relation to the chosen financial instrument.

What is the leverage effect?

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Because CFDs are leveraged products, it is important to define this concept as well.

Leverage allows you to open a much larger position with a smaller initial deposit. Thus, the funds required to open and maintain a position in the case of trading on margin (with leverage) represent only a part of the total size of the transaction. In other words, only a small percentage of the total value of the transaction will be deposited to open a position.

Through leverage, they increase market exposure and the chances of making more profits. At the same time, the account balance can be lost in full if the speculations do not materialize (if the market does not evolve in the direction expected by the trader). The advantage of leverage is the fact that it allows maximizing the investment, More precisely, trading large positions by investing small percentages of the total value of the transaction.

Knowing, taking and managing risks are essential aspects of CFD trading. The main reason is precisely because the leverage effect has the potential to increase profits, but also to amplify losses, in situations where the market evolves against the trader’s speculations.

Margin trading can be used in a variety of financial markets (forex, indices, stocks, commodities, ETFs, etc.) by both experienced and new investors. So the main advantage of leverage is that the investor does not need to have a large initial capital to be able to make important trades. Thus, leverage practically increases the capital available for trading. This benefit brings with it an equally important disadvantage. It consists in the fact that the losses are greater if the market evolves in the opposite direction to the assumed one.

Conclusions

Therefore, trading on CFDs represents a flexible tool through which investors can obtain profits in relation to the evolution of the prices of some assets without taking real ownership of them.

Being a complex instrument that also involves risks, knowledge and analysis of the market is required to make a smart investment. In this sense, future traders can consider prior investment in financial education through Vestor’s courses, which include aspects related to financial markets and CFDs, among others.