A contract for difference is a type of trading very similar to Forex trading, except it deals with more than just currency pairs. CFDs give you access to trading stocks, indices, and commodities as well. And just like binary options, CFDs do not require you to ever assume ownership of the asset in question. For these reasons, many traders find that CFDs are the most beneficial way for them to trade.
But this is a complex instrument, and it is not right for all traders. If you are unsure of whether or not this is right for you, our brief guide will give you an overview, and hopefully get you pointed to the right place.
How does this type of trade work? In practice, they are fairly simple. If you think a company is going to rise in price, you would buy a contract. If you think they are going to fall in price, you sell the contract. If you’re right in your prediction, you earn the appropriate amount based upon the amount of movement of price and the risk you took on, all multiplied by the leverage you used. More on this below.
And just like with binary options or the Forex market, you can trade an asset as it is moving up or down in price with equal ease, not incurring any extra costs for going “short” on a position.
Trading with Leverage
Leverage is one of those tools that can either really help you to make more money, or really hurt you. With CFD trading, the normal number you will work with is 20 times the amount you invest. So, if you want to trade with $1, you will actually have $20 worth of buying power. This can go up to as much as 400 times, though.
There’s a problem here that you might have guessed. This extra money isn’t given out for free; you are asked to pay interest on it, especially if your position stays open for an extended period of time. Many brokers will not allow you to keep a trade open overnight, and if they do, it is quite expensive. And, if you lose that borrowed money, you are responsible for it. Most brokers have a built in safeguard here, closing your position automatically if you have lost more with leverage than what is in your account.
Before you ever use leverage with real cash—even a small amount—we heavily recommend practicing first with a demo account. This way, you can see firsthand what it’s like to lose money with leverage. Yes, your earnings can greatly be increased with this trading tool, but your losses can be multiplied many times over. If you don’t have experience, losses are more likely than profits. Unfortunately, many traders see the allure of higher profits and jump right in only to awaken to a rude reality when their trades are shut down because they don’t have enough in their accounts to cover their position. You can’t fully replicate this in a demo account since most brokers won’t close a trade early on you in demo trading, but it is better than no experience at all.
Are CFDs For Me?
CFDs do have a lot of potential, but they require a little bit more technical expertise than binary options if you want to be successful. You do not need to have extensive trading experience to use these, but it does help. The decision to use CFDs or not is up to you. They have potential, but also great risk. If you do decide to use these, we recommend practicing first and starting out small before you start upping the ante. Contracts for difference are a great trading tool and have a lot to offer traders, but not all traders should focus on these. Read over our material and test them out for yourself before you make a decision.