CFD trading is referred to as a “Contract for Difference,” which represents the difference between the price when you buy and sell a CFD of a share, commodity, or index. In simpler words, a CFD is a contract between the buyer and a potential seller where both parties agree to exchange the potential difference between the price of the respective share at the time of opening and closing a trade.
It wouldn’t be incorrect to state that the CFD is a popular financial tool, as it allows traders to sell or buy a specified number of shares in a particular stock at a predetermined price for a defined timeframe.
The Underlying Asset – An Overview
An underlying asset in CFD is the specific price of a physical asset in the market, which can be a share in any or all in the following markets:
- The ASX
- The foreign exchange market
- The commodity
- The index
The price of the CFD essentially reflects the price of the underlying markets. It is important to mention here that CFD traders do not trade or own the underlying asset. Simply put, CFD trades involve betting on the future price of a particular asset. Also, all CFD providers have a “ProductDisclosure Statement,” where some are more detailed than others.
Important Note
A reputable CFD provider will have detailed information on costs, markets, and trading examples while also highlighting the risk of CFDs. You might want to check the detailed answer to what is cfd trading, so that you know what you are signing up for. We cannot emphasize enough the importance of taking out your tie to reading it before opening an account. If used correctly, you can increase your chances of making more money with less of your own capital, but with the use of great caution.
Why Do Traders Prefer CFD Trading
People prioritize CFDs for many reasons. Firstly, CFDs provide global market access. Also, trading CFDs allows traders to have access to a massive variety of markets across the world, with all the potential traders under one central account. Leverage is another potential reason why traders prefer CFD trading, as leveraged products mean that traders can magnify their profits.However, this aspect also applies to losses, so you must be aware of the aspect of leverage.
Best Part: The Ability to Go Short
When it comes to CFD trading, potential traders have the option to go short. Certain trading markets have rules that forbid going short or require the trader to borrow instruments before selling shorts. Nonetheless, it is possible to short CFDs at any time without initiating borrowing costs because the potential trader does not actually own the underlying asset.
Final Thoughts
CFDs are useful hedging tools, too. CFDs can help duplicate a short position by hedging the exact position size that is required. For instance, you might establish a long position on a potential asset that might be declining in value. By shortening the same asset, a trader can then potentially earn money from that price decline and actually compensate for some of the losses from going long. Rest assured, a hedge will also affect the profit that you can make, but it will also impact the amount of capital that you can lose.
