The term CFD stands for contracts for difference.
A contract for differences, as the name implies, provides a contract between two parties regarding the movement of the price of an asset.
There are several key features of a CFD:
- CFDs are a derivative product
- CFDs are leveraged products
- You can benefit from both their increases and their price drops
- We offer contracts for differences in nearly 1,500 global markets, including indices, stocks, currencies, commodities, and ETFs.
CFDs are derivative products
This means that the underlying asset does not actually belong to you – you only speculate whether its price will go up or down.
Let’s take an example with stock investing. You would like to buy 10,000 shares of Barclays, and its price is 280 cents, which means that the total investment price would be € 28,000 – not including the commission or other fees that your broker will charge you for the transaction. In exchange for this, you receive a share certificate, the legal documentation that certifies your ownership of the shares. In other words, you have something physical to hold on to until you decide to sell them, preferably for a profit.
CFDs are leveraged products
This means that the exposure to the market is greater as an initial deposit is required that is less than the total value of the investment. This means that the benefits or losses are significantly higher than in other types of investment.
Let’s go back to the Barclays example. Those 10,000 shares of Barclays at 280 cents cost you € 28,000 and not including any additional fees or commissions.
However, with CFD trading, you would only need a lower percentage of the total investment value to open a trade and maintain the same level of exposure. At XTB we give you a 10: 1 (or 10%) leverage on Barclays shares, so you would only need to make an initial deposit of € 2,800 to trade the same amount.
If the Barclays share price rises 10% to 308 cents, the value of the position would become € 30,800. So with an initial deposit of just € 2,800, this CFD trade would have left you a profit of € 2,800. That’s a 100% return on your investment, compared to the 10% return you would have obtained with physical stocks.
However, what is very important to remember about leverage is that although it can magnify your profits, it can also magnify your losses. So if the price moves against you, your losses could exceed your initial deposit – and that is why it is important to understand how to manage risk.
In which markets can you trade CFDs?
We offer contracts for differences in nearly 1,500 global markets and multiple asset types, all with the ability to use leverage and go long or short, including:
- Stock Actions
- Foreign exchange
- Raw Materials
You can benefit from both price increases and decreases
If you think the price of an asset is going to go up, you can go long or “buy”, and you will benefit from each price increase.
If you think the price of an asset is going to go down, you can go short or “sell”, and you will benefit from each drop in price. Of course, if the markets don’t move in the direction you expect, you will suffer losses.
So if, for example, you think Apple’s share price is going to go down, you can go short on the Apple share CFD, and your profits will rise in line with any drop in price below your opening level.
However, should Apple’s share price rise, you would suffer a loss for each rise in price. How much you can win or lose will depend on the size of your position (lot size) and the size of the price movement in the market.
The ability to go long or short, along with the fact that CFDs are leveraged products, are two characteristics that give them the ability to take advantage of short-term market movements.