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Your guide to CFD trading and how it works

by on May 17, 2022 in Business

Trading and investing can feel like an entirely different world, full of complicated jargon and numbers that are forever shifting on a bank of screens. It’s something you should not enter into on a whim, because it requires a lot of careful research and a deep understanding if you are to have a chance of being successful.

No matter which markets you trade in and which instruments you use, there’s always the risk of losing money as well as making a profit. So, with that in mind, it’s important that you build up your knowledge before you get started. For example, you might want to know a bit more about CFD trading, how it works and the pros and cons. If that’s the case, you’re in luck!

What is CFD trading and how does it work?

CFD stands for contract for difference. Essentially, you are speculating on the price of an asset moving up or down, without owning the underlying asset itself. If you think the value will rise, you buy – also known as going long. If you think the value will fall, you sell – also known as going short. If your prediction proves correct, you will make a profit. But if the market moves in the opposite direction, you will incur a loss. The more the market moves, the greater your profit or loss will be.

CFD trading is done on leverage, so you only need to put up a small percentage of the overall amount required. However, any profits or losses are worked out based on the full value of the trade, so you could stand to gain or lose a lot more than your initial deposit.

You agree to exchange the difference in value between the point at which the contract is closed and when it opens. The buy price is slightly higher than the market value and the sell price is slightly lower, while the difference between those two is called the spread.

What are the pros and cons of CFD trading?

CFD trading saw a major surge in popularity back in 2020 and it’s easy to see why, with the ability to trade on a wide variety of markets. Typically, you can also benefit from higher leverage than other forms of trading, which could mean greater profits from a smaller deposit. Of course, the flip side is that you also stand to make greater losses if things don’t go the way you anticipate.

CFDs are banned in the United States and are coming under greater scrutiny while there is not the same strength of industry regulation to protect you, so it’s important to be careful when choosing your broker. And because you have to pay the spread, it can mean you take a little bit of a hit even when executing a profitable trade.

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