Just by its name, you will know that Contract for Difference (CFD) involves a contract and it is between the trader and the broker. There are some characteristics of CFDs that can also be found in options and futures contracts. But what sets apart CFD trading against these two other investment options is its great opportunity to profit. Knowing its basics will help you get a heads up with your trading journey.
Defining Contract for Difference
Contract For Difference (CFD) is a financial investment that involves a contract between a broker and the trader. This contract provides profit to the investor out of the underlying asset without really owning it. This is also the way for the broker to profit because the losing party will be the one paying the difference between the entry price and exit price. Although CFD trading is only made available in certain countries, this type of investment is highly profitable and when used properly, secures a good amount of profit. CFD trading is only available for countries like Japan, Spain, Germany, United Kingdom, and others but it isn’t available in the United States.
How Does CFD Trading Works
The transaction happens between a CFD broker and a trader. Usually, CFD brokers are the ones that engage themselves in this type of transaction. The trading term is unique in every trader and it should be negotiated by the broker and the trader. The process involves taking a position of security as the underlying asset which is from the CFD broker. Since CFDs do not have an expiration, the trader will have to close it whenever he feels like doing so. Mostly, it is closed at the end of the trading day to avoid incurring additional charges for keeping the position open overnight. When closing the position and the trader is at the advantage, the CFD provider will be the one to pay the difference, which will now be the profit of the trader. Otherwise, the trader will be the one to pay the broker if he closes the position at a loss.
To trade CFD, the broker needs to open a margin account. This margin account ensures that a certain amount of maintenance margin is available in your margin account all the time. Throughout the process, the broker can benefit in multiple ways. Other brokers take commissions on every open trade or they can also get compensated whenever a bid or ask price is laid. There are also instances in which additional fees are deducted for keeping a transaction open overnight. Some brokers are also charging account management fees for the processing of the transaction.
When talking about the advantages, the major advantage of CFD is that it allows you to negotiate with the broker smaller scales of the contract compared with the futures contract. CFD allows you to trade at any given amount as long as the broker agrees to it. Another advantage is that it allows the trader to speculate on the security without owning it.