Trading, in general, can cost a lot. Whether you’re a beginner or a professional, you need to invest a lot of money to gain money. Fortunately, there are ways to help a trader make a profit by investing an achievable amount of money.
One of the most popular ways is CFD trading. It’s when a trader signs a contract with a seller, which indicates that they’ll be the part owner of an underlying asset. But since the buyer is a partial owner, they don’t have any rights to the stocks.
In addition, the profit will just come from the difference between the closing and opening of the position based on the contract. Basically, the price of the underlying asset doesn’t matter in terms of profit.
How does CFD trading work?
CFD trading works with leverage, which is the main feature of this popular financial instrument. As a trader, you can open positions by just paying for a percentage of the full value of the asset. The capital you pay to be able to open a position is called the margin, which is like a deposit that’s keeping your position alive.
CFD trading can be interesting, but there are things you should know first before diving into the pool of leverage. And what exactly is leverage? Here are five things you should know!
1. Magnifies gains and losses
With higher leverage comes greater risks, so it’s important to get to know the risks you may come across when you opt for CFD trading.
In CFD trading, leverage and margin trading can be risky depending on the situation. Basically, the main premise of CFD trading is that when the price of the underlying asset favours you, the CFD broker will pay you. On the other hand, if the price of the underlying asset favours the broker, you’ll have to pay them.
Unfortunately, the effect of the price change differs between the trader and the broker. Usually, even the slightest change can cost you a lot of money. It’s great if you gain more than you lose, but it’s unpredicted most of the time so you should be careful
2. Can get more exposure
Since you’re just paying a fraction of the full amount of the underlying asset, you can invest more and gain exposure. Imagine, when you opt for CFD trading, you’ll just have to pay for a certain amount and get the same exposure as if you paid in full.
So if you’re planning to gain exposure, you can trade as many times as you like via CFD. In addition, you can use your remaining capital for other things. However, to gain many exposures, you also have to win every position you open. If not, then you won’t be able to attain your target.
3. Margin rate differs from one broker to another
As mentioned, leverage works using margin or deposit. It’s the initial capital a trader will pay to start CFD trading and open a position. For instance, if the full value of a trade is $100 and the margin rate is 10%, your margin is $10.
However, the margin rate differs from one broker to another, so it’s hard to prepare an exact amount of capital. You need to find a broker first to make sure what the margin rate is.
In addition, you should also be aware of the leverage ratio. Since your exposure is the same as paying an underlying asset in full, your loss will also be calculated in the same way, and not based on the margin rate.
4. Margin calls exist
Do you want to keep your leveraged trade open? Make sure to avoid the margin call. The margin call happens when the funds in your account can no longer cover the margin. For instance, if the required deposit in your account is $500 and opening a position is $50, that’s a margin call.
When that happens, your open position is at risk of being closed. So before that happens, you should add additional funds to your account right away.
In some cases, depending on the contract, the broker may ask for additional payment whenever you reach a margin call. It’s usually because to remind from doing so.
5. There are other fees
As mentioned, there might be other fees required whenever you reach a margin call. But aside from that, in CFD trading, there are other fees to cover, like overnight financing. As you may already know, there are additional fees when you leave a trade overnight or after the market closed.
Furthermore, other fees like the spread, transaction, commission, and financing post. In terms of the commission, it usually happens for stock trading. As for commodity and forex, there are usually no fees for commission.
We hope these terms help you understand CFD trading more. And if you want to share more tips, don’t hesitate to leave a comment below!
ABOUT THE AUTHOR:
Aliana Baraquio is a web content writer at FP MARKETS, a global Financial Technology services Foreign Exchange (Forex) and Contracts for Differences (CFD) broker established in 2005. She also loves reading about interior design and home makeovers.