Basic
principles of CFD
A “Contract for Difference” is basically a contract agreeing to exchange the difference in contract price of a derivative or underlying asset's price. It includes global indexes,
commodity, stock or currency. If the price moves in favour of the trader, he would realise a real profit which equates to the price difference multiplied by the quantity transacted. His trading account would be credited accordingly. Conversely, if the difference is negative, the trader would realise a trading loss, and the CFD broker will debit this difference from the trader’s account.
A key point about CFD trading is that the the trader does not
actually trade the underlying instrument or index. Instead, what the
trader does is to initiate a contract between himself and the CFD broker
whereby he agrees to be paid (in the case of profit) or pay (in the case of a
loss) the difference in price when the contract is closed. A financing fee, or interest, is charged for the period of the contract. Depending on whether the trader is holding long or short positions, he could be paying or receiving interest while the CFD contract is still open.
An Example:
If you take a CFD trade to go long (i.e.
buy) on 200 shares of DBS at $11.80 and the price rises to $12.50,
then you profit from that change in price, just like you would from a
conventional stock broker.
Since you bought 200 units of DBS shares in
the Contract, your profit is:
($12.50 - $11.80) x 200 = $140,
excluding commission and financing cost.
The
value of the CFD tracks the underlying
DBS share price, and if the underlying DBS stock move in your chosen
direction, you can profit from the same change in price. The reverse
applies if DBS stock moved against your chosen direction.
As mentioned before, you can easily short sell CFDs as well, and therefore profit from falling DBS prices.
As mentioned before, you can easily short sell CFDs as well, and therefore profit from falling DBS prices.
In
Summary
CFDs
are traded on leverage to give traders
more trading power, flexibility and opportunities across a wide range of
financial products, all in a single platform. They are more suitable for
traders adopting swing or momentum trading strategies than "buy and
hold" due to the additional financing cost. That being said, CFD is a
tool and it is the trader that should decide how best to optimize his
trading Returns given the various options available.
