Alex Johnson Blog | Introduction to CFD trading – CFD Trading Explained | Talkmarkets
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Introduction to CFD trading – CFD Trading Explained

Date: Sunday, February 9, 2020 6:57 AM EDT

What Is CFD Trading?

The simplest definition of a CFD, or a contract for difference, is an agreement between two parties to exchange the difference between the opening and closing price of a contract for a financial instrument. Considered derivatives because they derive their value from the performance of the underlying asset, CFDs are also leveraged products that let you maximise your exposure to the market for a fraction of the price you would normally pay to own and trade the asset directly.

Often used for speculative trades, investors can profit by either taking long positions when they believe the price of the underlying asset will rise or short positions when they believe its price will fall. Depending on the CFD provider, contract prices may be offered for currencies, commodities, indices, shares, and other trading vehicles.

Key features of CFD trading

A relatively new trading option, CFDs were introduced in London in the early 1990s as a type of equity swap that could be traded on margin. Because they required only a small investment to hedge large exposures to financial markets, CFDs became a favourite of hedge funds and institutional traders alike. The real growth in the use of CFDs, however, was made possible by retail traders on the internet. What makes them different from other trading instruments? Let us take a moment to explain.

High leverage

The principal selling point of CFDs is that they provide significantly higher leverage than traditional investment vehicles. Although rates do vary, margin requirements as low as 2 percent are considered standard in the industry. In other words, you could go short or long £1000 of British Petroleum (BP) shares with a paltry £10 deposit. The fact that initial investment requirements are so low makes CFD an attractive option for individual traders. But high leverage trades can also be quite risky, since losses are magnified just like gains. It is in fact possible to lose more than your initial outlay if the difference between the opening and closing price of the contract is greater than your investment.

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