Key concepts in CFD trading
Contracts for Differences (CFDs) are very popular among traders and for good reasons. With the help of CFDs, it is easy to get exposure to a wide range of underlying assets and instruments, without actually owning them. You can even profit from index movements.
Another benefit of CFDs is that they nulify the need for short-selling. If you think the price of an asset is going down, simply select the right type of CFD. Not having to deal with risky, and pricey, short-selling is a huge benefit for traders who wish to be active even when prices are going down.
CFDs are also used for hedging. You simply open a position that will become profitable if another of your positions incur a loss. A person who purchases shares in Company A can hedge by opening a CFD that will be profitable if the price of Company A shares goes drops below a certain point.
Since no assets are changing hands during CFD trading, they broker fees tend to be very small. Some brokers do not even charge a fee; they make money on the spread instead. Always take the whole situation into account when you select which broker to use. There are a lot of CFD brokers available online, so there is no reason to stay with one that isn´t suitable for you. Open a CFD account with a broker that features the services and cfds that you want to have access to.
The two prices
CFD prices are quoted in two prices:
- Buy price (also known as offer price)
- Sell price (also known as bid price)
The sell price/bid price is the price at which you open a short CFD, while the buy price/offer price is the price at which you open a long CFD.
The sell price is usually slightly lower than current market price, and the buy price is usually slightly higher than the current market price.
The difference between the two prices are known as the spread. Quite a few CFD brokers money from the spread instead of charging the traders fees to open and close CFDs. To put it in other terms, the cost is covered in the spread, as the buy and sell prices are adjusted to absorb the cost of trading.
CFD trade sizes
Many brokers and platforms use a model where CFDs are traded in standardised contracts known as lots. The size of an individual contract will vary depending on the underlying asset or instrument.
Example: If you want to gain exposure to the silver price using a CFD, you are likely to find a CFD based on 5,000 troy ounces of silver. That is because 5,000 troy ounces is how silver is traded on the commodity market.
With many brokers and platforms, CFD trading is (in this regard) fairly similar to trading directly in the underlying. If you want to get exposure to 500 shares of Apple, you buy a 500 Apple CFD. This is quite different from how it works with derivatives (e.g. stock options) where calculating exposure is a bit more complex than for standard CFD trading.
CFD duration
A typical CFD will not have any fixed expiry time, but using CFD:s for long-term investments is not common. If you do not close your CFD before the trading day is over, you will have to pay an overnight funding charge. Leverage will add to the cost. The overnight funding charge is calculated based on the total value of the position and any leverage used.
Calculating profit/loss
How to calculate the profit or loss of a CFD trade? Take the total number of contracts (deal size) and multiply it by the value of each contract (per point of movement), then multiply the result by the difference in points between the opening-price and the closing-price.