CFDs offer an effective way for investors to trade without actually owning the underlying asset, but rather receiving revenue based on the price change of the asset.
A contract of difference (CFD) describes an agreement between a buyer and seller. As a contract, a CFD specifies that the buyer must pay the seller the difference between the current value of an asset and the value of the asset at the time of the contract.
CFDs are popular investment options for many traders, largely because they provide an opportunity to profit from a price movement without ever owning the asset – but how does it work?
Understanding How CFDs Work
Trading CFDs does not make use of any stocks, forex, or indices, but rather a contract of speculation.
CFDs operate as an advanced trading strategy that is mostly used by experienced traders. An agreement is drafted between an investor and a CFD broker to trade the difference in a financial product’s value between the time that the contract opens and closes. These financial products could be securities or derivatives.
Using this method of trading, a CFD investor never owns the underlying asset. Instead, the investor receives revenue based on the asset’s price change. For example, instead of buying or selling commodities, a trader speculates on how the price will vary, placing a bet on whether it will rise or fall.
Opportunities and Risks of Investing with CFDs
Trading CFDs is an advanced investment strategy, with opportunities and risks involved.
Opportunities of Investing with CFDs
When executed wisely, CFDs can offer the following opportunities and benefits.
- High leverage and tradeable on margin
- Opportunity to go short with high flexibility
- Option to trade 24 hours a day
- Access to global markets and different asset classes
Risks of Investing with CFDs
In the same breath, the following risks need to be considered when trading CFDs.
- Leverage can work against the opportunity for profit if the market turns
- No ownership of the asset or dividend rights
- Overnight fees for holding a leveraged position overnight
Note: Please do not invest money or assets in the financial markets that you cannot afford to lose. This article should not be construed to be investment advice and is for information purposes only