A CFD, or Contract for difference is one of many financial instruments that has grown in popularity recently, that allows users to invest and make money easily. A CFD is normally completed online and offered by several different unique trading platforms that offer customers this exciting way of making money. There are many different sites, one of which is called CMC markets that offers CFDs as well as many other ways of investing online, through the same online platform. Whilst money can be made by relatively inexperienced investors by using a contract for difference, it does require some research into the investment that is being made and a lack of knowledge of CFDs when entering into one is one thing that is of concern in the financial world of online trading. This can lead to customers who use CFDs for the first time losing a lot of money in a short space of time, that is very unexpected and is due to the fact that not a great deal of time and effort is put into understanding the associated risks. This has given rise to some skepticism and doubt towards the trading method in recent times and this short piece will look to straighten out what a CFD is and where people may be going wrong when starting out trading in CFDs.
What Actually is a CFD?
Essentially, a CFD is something in which the purchaser can speculate one way or another on the prediction of stocks in any of the usual senses, such as shares, commodities or indices etc. This method of investment can almost be thought of as a bet on what the price of the subject in question will do and the user does not actually own any of the shares that are bet on. The profit that is generated from the CFD trading scenario is the difference between the prices of the stock before and after the agreed upon contract.
The main difference is that CFDs are normally much shorter term and that it allows profit to be made despite the fact that a stock may fall in price, if your prediction is correct, you will make money equal to the difference in the share price you predicted. This allows much larger profits in the short term for a smaller capital investment, however, if the market does move against you, this can also mean that much larger losses can also be incurred than would be when buying shares outright.
Where Are People Going Wrong?
The main reason that many customers are going wrong with CFDs is simply because of a lack of knowledge in terms of the risks involved. Understanding what a CFD is and the differences between this and other types of trading is key to understanding exactly what a customer may be betting on.
It is important to understand the basics, so for example, if you invest in 100 CFDs on a stock and you predict that the stock will rise in the given time elapsed for the contract, then this is known as going short and at the end of the contract, your prediction is correct, you will make a profit. Say for example at the start of your investment, the value of each CFD is 50p and at the end it is 27p, the amount of money you make will equate to the difference, so:
(100 x 50p) – (100 x 27p) = £50 – £27 = £23 (Profit)
However, similarly, if the market was to move against you and the stocks are now trading at lets say 73p, your loss would be the same as your profit, a magnified amount and this is why CFDs are often said to have larger risks associated with them and for novice traders, can be a risky move.
The current notion is to try and reduce the amount of profit/loss that can be incurred by placing caps on the amount at which a share can deviate and this will effectively mean less profit can be made, but there is a much lower risk of losing money at the same time, something which is beneficial for inexperienced investors and will help protect a customer’s funds.