What is CFD

A Contract for Difference (CFD) is a financial derivative instrument that allows traders to profit from increases or decreases in the price of an underlying asset. The full English name of CFD is Contract for Difference, which means a contract between the buyer and the seller. According to the contract, the seller pays the buyer the difference between the current value of the asset and the position value (on the contrary, if the difference is negative, the buyer pays to the seller).

Features of CFDs

The characteristic of CFDs is that traders do not need to actually own or deliver the underlying asset, but only pay or receive the price difference. This can reduce transaction costs and tax burdens, and also increase transaction flexibility and diversity. CFDs can cover a variety of markets such as stocks, indices, forex, commodities, cryptocurrencies, and more.

Another feature of CFDs is that traders can use leverage, that is, they only need to pay a portion of the asset value as a margin to amplify the transaction size and profits. But at the same time, leverage will also amplify risks and losses, so traders need to pay attention to controlling risks and maintaining adequate margin levels.

How to trade CFDs?

The trading process of CFDs is as follows:

1. Traders select an underlying asset and decide whether to go long (buy) or go short (sell) based on their own judgment of market trends.

2. Traders pay or receive the difference between the opening price and the current price when opening a position, and pay a certain percentage of margin.

3. When closing a position, the trader pays or receives the difference between the closing price and the current price, and returns the margin.

4. A trader's profit and loss is the difference between the opening price and closing price multiplied by the transaction quantity, and then deducts transaction costs (such as commissions, spreads, overnight interest, etc.).

CFD Example

For example, let's say a trader wants to go long 1,000 shares of Apple Inc. (AAPL) CFD. Apple's share price is $200 when the position is opened and $210 when the position is closed. Assume that a CFD broker requires a 10% margin and charges a commission of 0.1% and a spread of 0.01%.

Traders need to pay $2000 as margin (1000 shares x $200 x 10%) when opening a position, and pay $200 as commission (1000 shares x $200 x 0.1%) and $2 as spread (1000 shares x $200 x 0.01%).

The trader needs to charge $21,000 as the asset value (1,000 shares x $210) when closing the position, and pay $210 as commission (1,000 shares x $210 x 0.1%) and $2.1 as the spread (1,000 shares x $210 x 0.01%).

The trader's profit and loss is $758.9, calculated as follows:

Asset value difference: $21,000 - $20,000 = $1,000

Transaction costs: $200 + $2 + $210 + $2.1 = $414.1

Profit and loss: $1000 - $414.1 = $585.9

The trader's return is 37.95%, calculated as follows:

Yield: $585.9 / $2000 x 100% = 37.95%

Conclusion

CFD is a high-risk, high-yield financial instrument suitable for traders with extensive experience and knowledge. Before trading CFDs, traders need to understand how CFDs work, the risks and benefits, and choose a compliant and reliable CFD broker. In addition, traders also need to develop reasonable trading strategies and risk management measures to protect their own funds and interests.