CFD – Contract for Difference (contract based on price difference), which allows you to trade assets and make a profit without physically buying the underlying asset.

CFD is a derivative product. When trading a CFD, you get the price difference between the opening price and the closing price of the contract. An impressive CFD bonus is earnings on the price movement, which can move in any direction. In this case, profit or loss depends on the correct forecast.

Most CFD providers for trading cryptocurrencies, stocks, indices, and other assets are market makers (brokers). They create market volume. The fact is that most investors trade in small volumes, insufficient to work on the exchange, where institutional investors buy and sell for big money. And in order to help small participants earn on stocks, bonds, indices, raw materials, and cryptocurrencies, the broker created the mechanism of CFD contracts – a “synthetic” market for small investments.

Long and short

CFD handel allows you to earn on price movements that go up or down. Thus, you can make a profit both on the growth and on the decline of quotes.

In the first case, this is a purchase – opening a long position.

In the second – selling, or opening a short position. For example, you are convinced that security will fall in price. Then you sell CFDs on your paper. You will still receive the price difference between the opening and closing of the position but will make a profit if the stock falls and make a loss if the stock rises.

For both longs and shorts, the profit or loss is realized after the position is closed.

How to earn on CFDs? Shoulder strength

Leverage means the money that the broker lends to the investor so that he can realize the transaction in a larger volume.

Leverage is a chance to earn more profit from the broker’s credit funds. You can make a deal for a larger volume without paying the full cost of the purchased assets. Let’s say you wanted to open a position equivalent to 500 shares of Apple. In a normal transaction, this would mean paying the full price of the shares upfront. Leverage 1:20 — the ability to pay only 5% of the cost.

At the same time, it is important to remember that profit/loss is calculated on the basis of the entire position, and the size of the leverage is not important. Both profit and loss can be significantly higher than the cost of the transaction. Losses may be more than your deposit. Therefore, it is worth looking at the leverage ratio and monitoring the situation so as not to go beyond your real capabilities.

Margin trading

Leveraged investing is sometimes referred to as margin investing because the money to open and maintain a position up to date – “margin” – is only a fraction of the total cost.

When you open a position, you need a deposit margin, while a maintenance margin is needed when trade approaches a losing position that is not covered by the deposit margin and other funds in the account. If this happens, you may receive a margin call from your broker asking you to fund your account. The account must be replenished in the required amount, otherwise, the position will be forcibly curtailed and losses will be fixed.

Hedging

CFD handel is used, among other things, to protect against risks.

Suppose there is a belief that a previously purchased security may sink for a short time, for example, as a result of negative news about a hacker attack and theft of money from wallets. So, you can compensate for some of the potential losses by opening a short trade through CFD.

If you decide to protect yourself from risks using this model, any decrease in the price of a crypto asset will be offset by the income from shorting using CFDs.

How do CFDs work?

There are four key components to the CFD price structure.

1. Spread and commission

Prices are presented in terms of purchase and sale prices (Bid and Ask).

• Contract purchase price (Bid) — open a short position.
• Contract selling price (Ask) — open a long position.

Selling prices are slightly lower than the current market price while buying prices will be slightly higher. This slight difference is the spread.

2. Contract size

CFDs are traded in standard lots. The size of an individual contract depends on the underlying asset, often mimicking the dynamics of the underlying asset.

Exchange-traded silver, for example, trades in lots of 5,000 troy ounces, and its equivalent CFD also has a value of 5,000 troy ounces.

For share CFDs, the contract size is usually one share of the company you are trading.

 

3. Contract expiration date (expiration)

Almost all CFDs do not have a hard expiration date. Instead, the position is closed by placing a trade in the opposite direction (opposite of the opening). For example, a position to buy 500 gold contracts would be closed by selling 500 contracts.

If you, for example, continue to hold a daily CFD position open after the close of the session, you will be charged a fee. The fee reflects the value of the capital your broker lends to you in order to open a leveraged trade.

This is not the case with all contracts. For example, in the case of a forward contract, it expires at a fixed point in the future and all overnight financing fees are already included in the spread.

 

4. Profitable and unprofitable situations

Profit or loss = number of contracts x (price at which the contract was closed − Price at which the contract was opened)

The formula above shows the net result for long CFD positions. If you are interested in calculating the result when opening short positions, simply swap the closing and opening prices of the contract.

To fully calculate the trading result, you need to subtract all commissions. These can be, for example, fees for holding or transferring a position by a broker.