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How Does CFD Trading Work?

by: wanitadof on Date: Fri, 29 Oct 2010 Time: 10:45 PM

A CFD is a simple contract drawn between a buyer and the seller to settle the difference between the opening and closing prices of an asset. This amount is normally multiplied by the number of underlying shares, during the process of settlement. Apparently, CFD trading is just like trading in ordinary shares. There is no quantity fixed to the number of CFDs you can trade. A commission is charged and the transaction amount is calculated by multiplying the number of CFDs with the market price.

Principle Features Of CFD Trading

Trading in contracts for difference has a handful of distinct features. Some of these include:

* You need not pay the full value of the transaction for the opening position. You are just required to pay a percentage of the same, known as the initial margin. This margin allows you to leverage. Therefore, you can enjoy an enhanced access to shares.
* With a CFD, you do not actually buy or sell shares. Therefore, you don't need to pay any stamp duty while trading.
* These contracts allow you to trade for long or short terms. When you buy an asset anticipating a price rise, it is known as trading long. When you sell an asset anticipating that the prices will fall and you will be able to buy it back at reduced prices, it is known as a short trade.
* A CFD will allow you to analyze shares and indices. Some providers may also allow you to trade on sectors and currencies.
* When you deal with a contract for difference, you are basically trading on margin, which is a high risk affair. Therefore, several risk management facilities are offered by the providers.

Understanding The Process

The best way of understanding the CFD process is through an example. Imagine you have $8000 floating capital for trading purposes and your provider is offering leverage up to 10:1. Now, you have about $80000 leveraged floating capital at your disposal for trading purposes. If the trade size is fixed to say $8000, you can enter 10 positions at one time.

Suppose the price of each contract was fixed at $5.50 when you decided to buy. Therefore, you would have bought $80000/$5.50= 1454 units. Now, if you have set the stop loss point at $5.25, and the price falls below the $5.25 mark; you exit the trade cycle incurring a loss.

Now assume a situation where the contract has done well and the price has appreciated to $5.75 and we have also trailed the stop up to $5.40. Further, if the price hits the $6.00 mark and the stop up is trailed to $5.90; when the price falls we exit the trade at $5.90. So the difference in price comes to $5.90-$5.50=$0.40. The total profit comes to 1454 x 0.40 = $581.

About the Author

If you are looking for some useful information on CFD trading and dealing with CFD,visit www.igmarkets.com.au. Here, you will be able to access relevant strategies and plans, which will help you trade successfully.

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