What is CFD Trading ? – Contracts for Difference –
CFDs or Contracts For Difference consist of a financial contract between two investors exchanging the value for the difference between the opening value and the closing value of an asset.
CFDs or Contracts For Difference consist of a financial contract whose price depends on the value of the different types of financial trading instruments (below). For example, a CFD on shares is a financial instrument whose price depends on the value of the chosen share.
If, for example, we would like to invest in Apple shares, purely for the sake of taking a trade, without wasting time on all of the associated bureaucracy, we could purchase a CFD on Apple shares from a broker and make a profit, if the Apple shares should rise in value. The value of the CFD will follow that of the underlying asset and allows for us to profit on the difference in price that has occurred. Obviously, in the case of the share losing value, the same idea applies and so the CFD would also lose value.
The interesting thing is that we can even profit on a share dropping in value by opening a “short” or “sell” position. There is no need to purchase the share beforehand and then sell it. It is simply a matter of predicting the depreciation of a determined asset in order to make a return on the investment.
What is the difference between CFDs and Shares?
There are some differences in aspect between CFDs and shares aside from a purely economic distinction. For example, a CFD does not give the holder a right to vote in a company, as a share would do. In reality, this counts for very little, as the right to vote often requires the ownership of a large quantity of shares.
CFDs allow you to profit from the dividends, as well as trading on the basis of the appreciation of the same asset. If we purchase a title for 1€ and then sell it at 1,3€, we have earnt 0,3€ from each title purchased. The transactions of purchasing and selling are completed much quicker and more conveniently than those of traditional share acquisition.
Another fundamental difference is the cost in commissions. Purchasing CFDs from an online broker is a very economical transaction in that the cost of commissions are much less due to an automated system. Some brokers, however, will offer personalized advice and support.
Yet another aspect or difference between traditional shares and CFDs is in financial leveraging that allows for the negotiation of higher prices to those that are actually held. These are a true strong point of CFDs, which are financially guaranteed. In fact, to open a position, it is necessary to have an initial margin of 0.5-30% of the total value of the trade.
Why trade CFDs?
Unlike trading with an offline broker or bank, trading CFDs gives you the ability to open trades on hundreds of top financial instruments without having to pay huge commissions.
The leverage allows you to maximize your investment by up to x50. So, each time you invest $100, you can actually trade with $5,000 and the potential profits might be respectively higher.
The biggest benefits of CFD trading is that you can start trading with small capital and potentially earn considerable profits.
Oil is quoted at $46.13 (SELL) to $46.18 (BUY). You assess the price of Oil as being under-priced and predict that the price of Oil will rise. You now open a Buy position and buy 50 barrels (amount) at the offered price ($46.18) and wait for the market to react.
If the price of Oil has increased and is now $46.23. You close the position and your potential profit is the sum of pips rised:
$46.23 – $46.18 = 5.00 +5.00 x 50 (amount) = $250 potential profit.
If your prediction is wrong, you may lose part or all your invested capital. However, you can limit your losses by using a Stop Loss order.
Do you need to be an expert to trade CFDs?
As in all sectors, the more you know the “territory”, the more effective you will be. So, even if taking a CFD transaction is a simple act, education, keeping up to date with new information and some effort will certainly help to obtain increasingly satisfactory results. Ultimately, you are dealing with the financial markets, therefore the more attention you pay, the more likely you are to profit from the various opportunities on the appreciation of the different assets available.
The Difference Between Binary Options and CFDs
When starting out in trading there can be some confusion as to which direction to take: binary options or CFDs? Today we will clarify all doubts by evaluating the most important differences between these two instruments, with the aim to help simplify the decision for our readers as to which of the two to start with. Obviously, when the time is right, both types of instruments can be used without any problems. In the meantime, make your choice based on your experience and your trading needs.
First of all, we will revisit what CFDs and Binary Options are.
Contracts For Difference (CFDs) are none other than a new type of futures that lend themselves extremely well to online trading because they make it possibile to negotiate (buy and sell) shares under the form of a CFD or, in other words, without actually taking possession of the title. This means that the process is more simple and much faster compared to the traditional trading of shares via a bank.
At the same time, it is absolutely secure and regulated. CFDs follow the movement and price of their underlying asset, without any alteration. This means that if a share rises, then the value of the CFD also rises in the exact same proportion. CFDs are also available on currencies (Forex), indices, commodities and Exchange Traded Funds (ETFs).
With regard to binary options, however, they allow us to analyse an asset’s movement in very short timeframes that can be as brief as 30 seconds. Unlike share CFDs, the trader does not earn in proportion of the title’s growth, but rather they earn a fixed percentage in the case of a correct analysis of the direction (high/low or up/down). An option trader can “guess” even by a minimum amount and this is enough to earn them a profit of around 75% of the investment sum. With an investment of $100, there is a return of $175 ($75 net).
The first major difference lies in the experience required. In fact, while with binary options there is the need above all for a general knowledge of the various mechanisms and dynamics present, over and above the study of the trend movement on real time graphs, when trading CFDs the expiry times are longer (even in day trading) and the investments are larger. It is the presence of leveraging that requires time and attention before using them to their highest potential.
As has been pointed out numerous times on this site, we recommend using a demo account both for the purpose of learning and for that of improving technique. The difference in this case is that while CFD trading platforms offer free demo accounts, binary option platforms allow use of a demo account only on opening a real account with a minimum deposit that is generally between 100 and 250€.
Minimum Trade Amounts
This element is in favour of binary options for the first steps in trading: lots or units. Lots are the minimum amount that may be purchased of CFDs and vary from title to title. For example, you can purchase titles from company X with a minimum purchase of 10 lots, but you may find another company with a minimum purchase of 100 lots. This renders the process more costly and the investment decisions more crucial. With binary options this mechanism does not exist.
Short and Extra Short Timeframes
One vast difference between binary options and CFDs is in the expiry time of the title. While in CFD trading you decide when to sell (and this can be done even during the same day of acquisition), in binary options the expiry is predetermined. This means it is established beforehand, prior to taking the trade. In this way you know precisely the point in time in which the clock will stop and you will then know if your analysis was correct (in the money) or incorrect (out of the money). The expiry times can be from 30 seconds or longer, so you could actually make a profit in just 30 seconds.
To sum up, we can say that while trading CFDs requires a certain level of experience, that can even be acquired to a degree on the demo platform, in binary option trading it is all decidedly more simple. In either case, whichever method you choose to go with, we highly recommend a few weeks of practice on your demo platform. Trading binary options is definitely simpler, but we are certain that you would gain much satisfaction also in the trading of CFDs when you so choose to use this method.