CFD stands for contract for difference. This means it is an agreement between you and your broker to exchange the difference between the opening price and closing price of a contract. Hence, you bet on the movement of the underlying asset (a stock, commodity, etc.), but you do not own the asset. CFD trading allows you to take a position on the price of an instrument without actually owning the underlying asset. One of the most unique aspects of CFDs is that they enable you to profit from falling markets as well as rising ones.
A CFD is an easy way to trade for example commodities or indices because of its simplicity, ease of trade, the ability to use leverage, ability to short sell and effectiveness. CFDs are cash settled, this means that you are not obligated to deliver real coffee if you sell coffee. In fact, the two parties settle their deal by paying/receiving the gains/losses of the deal to each other. When you buy a CFD you do not own the physical product (for example a share). Instead, you simply profit from the price movement of the underlying (underlying is the specific asset the CFD is on, for example, a share, gold, or an index like the DAX).
HOW A CFD WORKS
If a stock has a price of €25.26 and 100 shares are bought at this price, the value of the transaction is €2,526. When buying these shares via a traditional bank, the trade would require the sum of €2,526 cash outlay from the trader. With a CFD you do not have to pay the full price of this transaction, instead, you only have to use a partial percentage of the transaction value, which is called margin. The margin for stock CFDs is 20%. For our example, this would mean, that you could enter the trade with a cash outlay of only €505.20 (2,526 x 20%). In this case, you can trade a nominal value of €2.526 with an investment of only €505.20. This is called leverage. In the example you trade 5 times the value of your investment, therefore using a leverage of 1:5.
It should be noted that when a CFD trade is entered, the position will show a loss equal to the size of the spread. So if the spread (link to spread article) is 5 cents with the CFD broker, the stock will need to appreciate 5 cents for the position to be at a breakeven price. If you owned the stock outright, you would be seeing a 5-cent gain, yet you would have paid a higher commission than if invested with CFDs.
As mentioned before CFDs provide the possibility to use leverage. The leverage for CFDs begins with a margin requirement as low as 3.3% for major currency pairs. Depending on the underlying asset, margin requirements may go up to 100% (e.g. cryptocurrencies). Lower margin requirements mean less capital outlay for the trader/investor, and greater potential returns. However, increased leverage can also magnify losses.
HOW NGC & FIAT BASE CURRENCY ACCOUNTS WORK WITH CFDs?
The instruments the investors are trading are in US dollars or Euro, for example. If they are trading BTC/USD then the prices they trade on are in US dollars. If the account base currency is in NGC and NGC/USD rate rises, then the floating P&L will be less NGC since the base currency will be worth more.
The value of the P/L is not changing, as you have to always see the value in Fiat currency (even if your base account is in NGC)
Same happens also in fiat base currencies.
So, in conclusion, CFDs provide an excellent alternative for certain types of trades or traders, such as short and long-term investors, but each individual must weigh the costs and benefits and proceed according to what works best within their trading plan.
Now that you’ve learned some things about CFDs, we suggest that you go to NAGA Trader and explore CFD trading. Use the platform extensively to take advantage of this interesting instrument.