What are CFDs

price chartWhat are CFDs? A CFD is a Contract for Difference, which is a way of making money from the movement of share prices in the stock market without the requirement of owning the share itself. Instead of buying the share, you own a contract instead. It is this contract that you buy at one price and then sell at another, either making money, or potentially losing money.

What are CFDs compared to conventional share dealings?

If you deal in shares, you need to own the full value of the shares you are buying or selling. With CFDs, you only need to own a percentage of the share value up front. This is called the Margin Requirement. With equities it starts at 5% of the full value. So if you invest in a 10,000 position, your initial margin would be 500. When you trade on margins, you are able to earn or pay interest on your position. Another great advantage of trading in CFDs is that there is no minimum on the size of the trades you are allowed to place.

What are CFDs main advantages and disadvantages?

Trading in CFDs sounds almost too good to be true, but naturally there are some disadvantages to be aware of and although there is a huge potential for big returns in trading CFDs, you can potentially lose more money that you initially invested.

There are two types of CFDs and these are known as Long CFDs and Short CFDs.Long CFDs are when you believe that the share price or index will rise. You buy CFDs to make a profit when it goes up, or a loss if it should fall instead. In CFD trading, this is known as a Long Position.

Short CFDs refer to making money on CFDs even when you think that the price of a share or index might be in danger of falling. You sell your CFDs at a high price with the intention of buying them back again when the price falls. This is known as taking a Short position.

With long CFDs, the maximum amount of money you could lose would be the notional value of the CFDs you bought. However, the stock market would need to fall to zero before that could happen. With short CFDs, there is potentially no limit to the amount of money you could lose. If the price of your position continued to rise, you would keep losing money until you closed the position.

One main disadvantage is that you might need to make further deposits at very short notice if your positions move in the wrong direction, so you need to have the funds available at your disposal.

Trading in CFDs is not for everyone and before you consider getting involved you should give a great deal of thought to how much you are willing to lose should things go awry. However, CFDs are open ended, so as long as you can continue to keep financing your position, you can keep the contract open for an unlimited period if you are hopeful the position will recover sufficiently.