Thursday, March 17, 2016, AM | Leave Comment
CFD stands for Contract for Difference and is essentially the difference between entry and exit of trade. It is a tradable instrument which follows the underlying asset’s movements.
Though a CFD trader either makes profit or loss, actual underlying asset is never owned. CFDs are essentially contracts between broker and client.
There is an inherent advantage of CFDs, especially from the margin perspective.
Let’s suppose, ask price of a stock is $20 and a trader buys 100 such stocks. Therefore, the total transaction cost is $2,000.
If your trade is done through a traditional broker, he will ask for 50 per cent margin. In this case, it’ll translate to a cash outlay of at least $1,000.
If the trade is done through a CFD broker, it will only ask for a 5 per cent margin. This means the trader can enter the trade by putting in a cash outlay of just $100.
You may find more CFD trading examples at CMC markets CFD trading.
Some More Points to Elucidate why you should trade in CFDs
CFD trade involves a spread, which will be shown as loss equal to the spread size. Now, suppose there is a 5 cents spread. For reaching breakeven price, 5 cents appreciation of the stock is required.
The trader could have seen a 5 cents profit if instead of trading in CFD, he/she traded the stock itself. In fact, the trader could have paid a commission and also had a larger outlay of capital.
If value of the underlying stock continues appreciating and the bid price of $20 is reached, the trader can sell 100 units of the stock to make a profit of $50. As 50 per cent margin ($1,000 here) has been invested for starting the trade, the profit percentage earned turn out to be 5 per cent.
When underlying stock reaches $20.50, CFD price may only be $20.48. (It must be said in this context that a CFD trader may have to give up few cents in profit owing to the fact that spread in CFD is larger than that in actual stock market and at bid price a trader must exit CFD trade.
That’s why instead of 50 cents, the trader earns 48 cents.) For 100 unit traded, the profit equals $48. As we know, the initial margin given was only $100, the return on investment therefore becomes $48/$100 = 48 per cent.
Therefore, the extent of money earned in relation to the extent of money invested is much more in a CFD trade than in the traditional trade of the underlying stock.
Advantages of CFD Trade – At a Glance
2 per cent to 20 per cent margin is usually required in CFD markets. As capital outlay is less in case of Contract for Difference, the traders get increased leverage. CFD traders get a single global market access platform.
There are no shorting rules available and most importantly no fees are attached to professional execution. In fact, wide array of trading options (commodity, currency, treasury, index, stock, and sector CFDs) are available.
These are the reasons why it is more profitable for you to trade in CFDs than in the underlying stocks.Facebook.com/doable.finance