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July 11, 2020

IronFX, What is CFD Trading?

What is CFD, the contract for difference? What's the merit to invest in the CFD markets?

What is CFD?

CFD Trading

CFD trading is about creating the contract between “buyer” and “seller”, where the 2nd one will pay the price difference at the contract execution time.

CFD (Contracts for Difference) offer leveraged long-term or short-term trades, with a broad selection of financial instruments, including currencies, indices, commodities and shares.

CFDs are a flexible and accessible trading option that is based on the change of price in multiple commodity and equity markets, with leverage and immediate execution.

There are over thousands of CFD products including Stocks, Indices, Commodities, Metals, Bonds and Cryptocurrencies.

Known globally as the Foreign Exchange Market, Forex is the exchange or trade of international currencies. Having become one of the most significant markets worldwide, Forex plays the vital role of determining global currency exchange rates.

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What’s the merit to trade CFDs?

  1. CFDs are traded on margin, so you can maximize your trading capital. Rather than pay the full value of a transaction, you only need to pay a percentage when opening the position, called initial Margin. The key point is a Margin allows leverage, so that you can access a larger amount of shares, than you would be able to if buying or selling the shares yourselves.
  2. No stamp duty is payable. Because with CFDs, you don’t actually physically buy the underlying shares, you don’t have to pay stamp duty, saving 0.5% when compared to a traditional share-deal.
  3. You can profit from falling or rising markets by trading long or short.
  4. A single account can give you access to a far greater range of financial markets.
  5. You can limit and manage your risk, using stop losses and limit orders. A stop loss is a price level set by the client on a particular trade that if reached, automatically closes out the particular position at the desired price. A limit order is one that is executed at a better price than the prevailing market price. i.e. For a long CFD trade on the stock drops to a certain level or for a short CFD trade on the stock rises to a certain level.

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Example of Stock CFD trading

For example, a company’s share selling price is $25.29, while a buy price is $25.30.

If a trader is expecting the price growth, he will buy assets.

Let us say, this trader bought 1000 shares. If his prediction is correct, and the share increased $1 in price, reaching $26.30 mark, this $1 difference means $1000 profit for the trader (excluding the commission fee).

In case of the loss-scenario, the price of the asset will be reduced and the trader will lose the equivalent amount.

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Example of Index CFD trading

Let’s take a look at another example of a CFD trade using the popularly traded DAX 30 index as an example.

In the following theoretical example, the DAX is currently trading at a level of 9610.5/9611.5, giving me the option of selling the German index at the 9610.5 level or buying at 9611.5.

I decide to buy £5 of the DAX at that 9611.5 level, and my nominal risk in this instance would be worked out as follows;

(Level I’m buying at x the amount I’m buying)

So in this case the nominal risk would be:

9611.5 x 5 = 48057.5

£48,057.50 is the maximum amount of money I would stand to lose if the DAX dropped from its current 9611.5 level to zero.

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