What is CFDs Trading and How They Work - TopAsiaFX

022, Dec 2021

However, after the English brokers came up with a CFD, anyone could trade anything anywhere while having only one trading account with one of the brokers.

This is because CFDs are not the asset itself, but rather just a deal for the price difference. With this contract, you only can get the difference in price from the moment the contract is signed to the moment it is closed, and you do not own the asset itself.

This makes CFDs much more convenient, cheaper, and simpler than trading in standard futures or options.

What are CFDs (Contracts for Difference)?

CFD is a type of transaction between two parties regarding the value of a financial instrument in the future, in which both parties undertake to settle an amount equal to the difference between the opening price and the closing price of the trading position.

So what is a CFD? Let me try to explain CFD's meaning in more detail. CFD is a“contract for difference”, and it is a contract or transaction between a seller and a buyer with the aim of making a profit from the future difference between the closing and opening prices.

If the closing price is higher than the opening price, the seller pays the difference to the buyer, and if the closing price is lower than the opening price, the buyer pays the difference to the seller.

And of course, since a CFD contract is a derivative financial instrument, in addition to the difference itself, it also regulates the time during which this difference is determined.

Initially, the main task of the contract for the difference was to make stock trading available. And since stock CFDs are the most popular ones, we will look at what is a CFD in trading as an example.

Let's say you want to buy 100 Boeing Company stock contracts. The cost of one stock is $160. In order to buy the stocks themselves, you will need $16,000.

But when buying stock CFDs, you do not need to have the entire amount on your trading account, you only need the margin. The LiteFinance broker has a 2% margin on stocks.

So to buy 100 lots of #BA (Boeing Company) stock CFDs, you need only 2% of 16,000, which is only $320 + a small commission, which we will not take into account yet. Several days passed, and the stock price rose to $170 per stock. The price has increased, which means the seller must pay us the difference, which will be equal to 170 - 160 = 10 dollars. Now we multiply 10 by the number of contracts (100) and get 1,000 dollars.

Now let's see what we would get by purchasing the stocks themselves, and not a contract for difference.

Imagine we bought 100 stocks for $16,000, the price rose to 170 and the value of our stocks increased to 17,000. 17,000 - 16,000 = 1,000. So we got the same 1,000 profit, but in the case of stocks, we would need $16,000 on the account.

In the case of CFD products, we only needed $320. And if there’s no difference - why pay more? This is basically the main advantage of CFDs over trading the underlying asset itself.

To summarize, it becomes clear that with contracts for difference, we can make transactions that were previously unavailable to us on any exchange. We do not need to have a lot in our trading account to make huge profits.

In my example, we got 1,000 dollars of profit by investing only 320 dollars, and this is more than 300% of the return on investment, which is almost impossible when working with the asset itself. Continue reading on LiteFinance.