Trading CFDs for beginners: a complete guide

The contract for difference (CFD) is a speculative financial product, which follows the price development of an underlying asset such as shares, bonds, indices, commodities, or cryptocurrencies. Due to the leverage effects, very high profits or losses can be achieved with a small stake in a short period of time. In CFD trading, a “margin” must be provided as collateral, which acts as a security for the open trading position. Due to the leveraged position on the underlying asset, a margin call can occur while trading CFDs. This means, that the trader will have to provide additional funds to the margin, due to ongoing losses of the trade.

How do CFDs Work?

CFDs are derivatives, which means that you do not own the respective underlying asset, but only trade its price development for a certain period of time. Unlike binary options, you not only commit yourself to the rise (long position) or fall (short position) of a price, but it is the general price development that defines the profit or loss of the trade. In CFD trading, only a fraction of the amount of an underlying asset needs to be invested, also known as the “margin”. Thus, trading can be done with multiple available funds.

At the same time, however, the trader needs a cash reserve additionally to the invested amount as well. Due to the high risk, a bigger loss or cost of the trade as initially expected (margin call) can easily occur. Due to this, the risk management of the trader plays a very important role when trading CFDs. When opening a CFD position, the trader has to choose the amount of leverage in the trade. The spectrum of leverage can start at 1.25 times the invested capital and reach over 100 times the invested capital. The smaller the investment (margin) in relation to the value of the underlying asset, the greater the leverage and risk. Conversely, the higher the investment (margin) at the beginning of the trade in relation to the underlying asset, the lower the leverage and risk of the position.

Important things to consider when trading CFDs

Contrary to other financial tools, with a contract for difference position, there are no limited terms. Every trader can hold the investment for as long as she or he likes, depending on the strategy. Thus, for example, an originally short-term planned, but unsuccessful, trade can still be “saved” with a longer investment period. In this case, however, possible additional costs for the longer holding period must be taken into account. For this reason, a CFD trader needs to closely monitor the costs of the open positions and adjust risk accordingly. Regarding costs, different platforms, have different cost structures. Most CFDs have an opening fee (percentage of the amount traded) and recurring holding fees (daily, weekly, or monthly basis). Most platforms use fee structures, where costs get smaller, as the amount of the trade gets bigger. It is very advisable to analyse the cost and fee structure of the CFD platforms before you start to trade, there is a huge difference in the market and among the CFD providers.

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