The world’s financial markets have continued to grow and diversify over time, giving rise to increasingly popular investment vehicles such as CFD trading in the process.
In 2018, for example, there were approximately 800,000 CFD-funded retail client accounts active at the end of 2018, while around 279,000 client accounts traded contracts for difference every month.
But what exactly is CFD trading, and how does this work? We’ll answer these questions and more in the article below.
What is CFD Trading?
As we’ve already touched on, CFD trading stands for ‘contract for difference’, which is a speculative investment vehicle that’s focused on the price of a particular asset or financial instrument.
In this respect, it eschews the need to own the underlying asset, creating far greater flexibility and freedom when it comes to delivering a profit.
With CFD trading, you’ll speculate on the movement of a target asset’s price, with this type of derivative product typically synonymous with short-term price speculation. It also allows for margin trading within a predetermined period of time, with the extent of your profit ultimately determined by the difference between the buy and sell price.
You can also go ‘long’ and ‘short’ with CFDs. So, if you speculate that a particular price will rise during a particular time-frame, you’ll buy (go long) and wait for the appreciation. Conversely, you’ll assume a ‘short’ position, you’ll look to sell in anticipation that the price will decline.
But how does this work in practical terms? Well, let’s say that you want to profit from gold, which is likely to rise in value against the backdrop of the Russia / Ukraine conflict.
However, rather than buying-and-holding gold as a tangible store of wealth, you could instead go long on the asset and speculate that the price will rise in the near-term.
This is an excellent way of engaging in leveraged margin trading and optimising potential returns, while minimising your exposure to risk in the marketplace.
Ultimately, your choice of whether to go long or short will depend on your target asset and the relevant market conditions, but this is an example of how CFD trading can work in the real world.
When to Try CFD Trading
While you’ll need strong market knowledge and a keen sense of determinism to make a success of CFD trading (due to the nuance and complexity of such trades), there are numerous benefits to this discipline.
For example, the derivative and speculative nature of the vehicle makes it possible to profit even in a depreciating marketplace, while you also retain the flexibility to go long or short depending on your analysis.
As you can also trade on margin, this allows for highly leveraged trades that can translate into disproportionately large returns over time (or similar losses if the market works against you).
With these points in mind, there’s clearly a balance to be struck when implementing CFD trading. Certainly, you should have some experience and knowledge of the market before placing this type of trade, while also deploying determinism to understand the underlying rules that govern change in the market.
So, if you’re a relative novice and someone who’s still learning your trade, it may be worth adopting a much simpler strategy and scaling your efforts organically before entering the world of CFD trading.
