What is CFD trading?

CFDs are considered a relatively new trading instrument that is gaining increasing popularity among traders and investors.

While five years ago we might have encountered just a couple of such assets in our MT4 trading terminal, today the range of various instruments is so vast that some forex brokers have begun offering separate account types for CFD trading, which, when opened, provide you with a full range of services for trading this asset.  

So what is a CFD? A CFD is a special type of financial asset that represents a contract for the difference between the opening and closing prices of a trade.

In layman's terms, when trading CFDs, you and I enter into a kind of contract with each other or a broker. Upon closing, the difference in price between the opening and closing of the trade is received as a profit or loss, depending on the direction of the asset's price.

With the introduction of this tool, all traders can try trading shares without actually owning them, and you can open both a buy and sell position.

CFD trading is no different from trading the currency we are all familiar with, and the only difference between them is the contract specification.

CFDs or Shares

Many beginners are interested in the difference between trading CFDs on stocks and actually trading stocks. Trading actual stocks on the stock exchange requires tens of thousands of dollars in capital, and if you buy shares, the exchange charges you a commission to list you as a shareholder.

This takes not only money but also time, preventing you from profiting from exchange rate differences right now. Also, to profit from exchange rate differences, you need to own the asset, so on the stock exchange, unlike with CFD trading, you can't sell what you don't own.

When trading contracts for difference, you're essentially trading air, or, as you might imagine, nothing, so there's no time lag and no commission. A CFD is a derivative asset that's calculated based on an underlying asset, such as a real stock, index, or commodity. 

Thus, thanks to this feature, almost any trader with at least one hundred dollars in their account has the opportunity to trade CFDs on stocks and profit from changes in their price. You also have the opportunity to use leverage of 1:100, which no other stock exchange broker can offer.

Thanks to high leverage and the ability to open positions in any direction, a trader working with CFDs on shares has more potential to earn money than a stock market player.

CFDs and Dividends

There's a myth circulating on Forex websites that when trading stock CFDs, if you hold a long position on the dividend distribution day, you'll receive your interest. Unfortunately, this is nothing more than a myth, as if this were true, many would specifically buy stock CFDs before the dividend distribution, and with the huge leverage offered by brokers, they could earn substantial profits.

In fact, we do not own the underlying asset, namely the share, which means that we have neither the right to vote at meetings nor dividends as such

CFD and Hedging

Stock CFDs are primarily of interest to investors and hedge funds. Why, you ask? Let's consider a typical situation where you, as an investor, have purchased shares to preserve your funds and profit from dividends. However, the market situation has developed such that all the shares you purchased begin to fall in price.

This is when CFDs can help you preserve your capital, as you can open a share CFD trade to sell the same amount as the shares you bought and use the profit you make to offset any losses due to falling prices in your investment portfolio .

In summary, it's safe to say that CFDs are nothing less than a unique opportunity for brokers, allowing traders to experience all the joys of trading stocks, futures, and indices without the huge capital required to trade the underlying instrument. 

Remember that CFDs are a highly liquid instrument, so using high leverage can result in both large gains and losses.