What is CFD Trading? Contract for Difference
When trading financial instruments (stocks, bonds, etc.), the difference in price between when an instrument is bought and when it is sold is called the “contract for difference”, which is where CFD trading gets its name.
CFDs (Contract for Difference) are highly structured derivative financial contracts that allow you to invest in a security without having to own the underlying security.
You can buy, sell, or go short CFD contracts.
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With CFD trading, you are actually betting (speculating) that the price of the underlying security will move a particular way (up or down).
To trade CFDs, you can buy a contract (via your broker) from a seller and the contract will stipulate that the person selling the contract will pay you the difference between the price of the security when the contract was entered into, and the price of the security on the contract termination date.
Example of CFD Trading
- Day 1: You buy a “Contract for Difference” contract
- Day 1 of contract: Underlying stock price is $500
- Contract term: 4 weeks
- At the end of 4 weeks, the underlying stock price increases to $750
- The seller of the contract will pay you $250 per contract.
- If the stock price had dropped to $400, then you would pay the seller of the contract $100 per contract
Contract for Difference – Additional Information and Overview
CFD trading is not permitted in the United States.
This is because it is classified as an unregulated over the counter (OTC) financial trade.
The United States has very tight regulations that govern over-the-counter trading.
Many other countries around the world permit CFD trading, including but not limited to Canada, the United Kingdom, Japan and Australia.
One reason that some traders like CFD trading is because you don’t need to invest as much cash when making a trade.
On a regular margin transaction, you need to have 50% of the actual purchase price to utilize your margin. On a CFD, that amount is reduced a great deal, often to 5% or less.
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