A contract for difference (CFD) is a financial derivative that allows a trader to speculate on fluctuating prices without taking ownership of the rapidly expanding global financial markets. This includes stocks, commodities, indices, forex, stocks, and all without having to own the underlying assets. A trader can profit from the difference between the opening and closing price of a particular CFD instrument. While CFDs maximize the trader's profits, it can also significantly increase the risk of losing your money.
In CFD trading, if the price goes up, the provider pays the profit, but if the price goes down, the trader pays the loss to the broker, it's a two-way contract.
When you trade CFDs, you hold a position on the fluctuation in the value of the underlying asset. You are essentially betting on whether the price of the instrument will go up or down compared to when the contract was executed.
All CFD providers allow investors to trade long (buy a CFD with the expectation that the price of the underlying asset will rise) or trade short (sell a CFD with the expectation that the price of the underlying asset will fall).
The dealer and broker agree to exchange the value of the asset between the opening and closing dates of the contract. This contract reflects the change in the price of the underlying asset with the investor's position.
CFDs are one of the most traded financial instruments in European markets. Its popularity is increasing as traders around the world become more familiar with this trading system. Predominantly traded through a broker rather than on an exchange, CFDs offer investors looking to increase profits fully built-in leverage and use a much more flexible tool to gain insight into the strength or weakness of long-term assets or the performance of indices invest.
Risk in CFD trading
CFD is a high-risk investment that is not suitable for those with low risk tolerance. Some of the risks include:
investment risk; the market may move against your expectations and some or all of your investments may be lost.
counterparty risk; this occurs when the CFD provider or the counterparty to the CFD contracts fails to fulfill its obligations to you; this can result in a significant loss.
customer money risk; the risk of giving up some or all of your money held by the CFD provider.
liquidity, gapping and execution risks; market conditions may compel you not to trade if you choose to do so.