An Introduction to CFDs – A brief guide
Introduction to CFDs – A brief guide! CFDs are simply contracts that allow traders to take advantage of asset prices moving in one direction on the other – upwards, or long positions as well as downwards, or short positions. In effect, a CFD is a great opportunity for investors and traders to make profits on various price movements without actually owning the respective asset. It is actually a very simple contractual agreement, and everybody can try CFDs on major cryptocurrencies, as well as other assets such as stocks and bonds. Let us take a deeper look at how CFDs work. In the financial field, a contract for difference – or a CFD, as it is more widely known – is a legal contract between two parties – in this case described as ‘’buyer’’ and ‘’seller’’, that stipulates the seller will pay to the buyer the difference between the current value of a given asset, as well as its value at contract time.
How Does a CFD Actually Work?
The mechanism behind CFDs is actually very simple to understand. CFD’s are quotes in two prices: the buy price, and the sell price respectively.
- The sell price (or the bid price) is the price a which a trader can take a short position on CFD.
- The buy price (or offer price) is the price at which a trader can open a long position on a CFD.
Since sell prices will always be slightly lower than the market price, and the buy prices will be slightly higher in turn, the difference between these two opposed prices is called the spread. Further on, CFD’s are usually traded in standardized contracts, which are also called lots. Now, the size of the lot depends on each individual contract, and it is mainly influenced by the intrinsic value of the asset that is being traded. For instance, silver is traded on commodity exchanges on lots as big as 5000 troy ounces – consequently, its equivalent CFD contract value is equal. Let us take a look at another example. Say, a stock’s asking price is $25,26. If the trader buys 100 shares, the cost of the transaction should equal $2,526, with commission and fees included. While a traditional broker will require at least $1,263 in free cash for a trade, a broker under a CFD contractual obligation will require just 5 % margin. This sounds very complicated at first, but it is very easy to understand once you grasp the basics. Now, let us take a look at some advantages of CFD to put all this information into perspective.
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CFD brokers offer mainly the same service as traditional brokers – stops, limits, contingent orders, and so on and so forth. Some brokers even offer traders guaranteed stops by charging a certain fee for the service, or reimburse the trader. Similarly, CFD brokers make their living by taking a certain percentage from the spread, with absolutely no fees involved. Of course, the spread can vary in size depending on the market realities.