Stock CFDs
Trading Instruments
Stock CFDs
CFD trading is essentially trading without owning the underlying assets.
What Is It, How It Works, And Why You Need to Know About It
CFD trading is essentially trading without owning the underlying assets. If you’re trading CFDs, you’re typically making a contract that states that you’ll pay (or get paid) the difference between a specific asset’s prices at the current time and the time of the contract. So, if there’s a price change between the trade’s entry and exit, it must be paid, as per the contract.
Why do CFDs matter to traders? Because they are a fantastic way to gain exposure. You can enter the market without actually owning any underlying assets. That means that you don’t need massive investment and trading funds to begin your journey. Not to mention, with CFDs, you can go both long and short.
How to Start
What is CFD Stock Trading?
Because CFDs allow you to trade with leverage, they aren’t only accessible to a chosen few. Leverage is borrowed funds that you use to improve the potential return of an investment. Thus, you can gain more exposure with less capital.
Greater leverage seems like an indisputable benefit to most beginner traders. However, it’s the proverbial double-edged sword of trading. More leverage means that you don’t need to invest as much money as you would have to with other types of trading. But it also means that your risk of loss is more significant than it would be. Why? Because all your market movements (be they losses or profits) are calculated at full position value.
Trading Stocks vs. Trading Stock CFDs
The main difference between CFDs and trading stock shares (or any other trading, really) is in the ownership. When you trade stock CFDs, you aren’t taking ownership of the underlying assets. You’re only speculating on their market price and making a profit if you’re right.
However, when trading stock, you need to actually own the shares you’re trading (in most cases).
The main advantages of CFD stock trading lie in its other differences to share trading:
- Higher leverage — trading stock CFDs means you can trade with higher leverage. You only have to put up a fraction of the trade’s value to gain full exposure. Of course, at full exposure, as mentioned, your losses can exceed your deposit, which is a drawback.
- Two-directional movements — unlike with share trading, you can go both long and short. In other words, you can profit on all markets, no matter if they are rising or falling. With shares, you can only trade on rising prices.
- Immediate cash settlement — after the contract is up, the payment happens immediately.
- No overnight risk (if you avoid it) — you can leave your positions with CFDs open overnight. However, all changes will affect your position, which is why this isn’t recommended. It’s better to trade stock CFDs short-term.
- Access to a wide range of markets
- 27-hour trading
- With CFDs, you can use a wide range of instruments, while with stock trading, you’re limited to shares and ETFs.
STOCK CFDS
How Does Trading Stock CFDs Work?
In order to fully explain how trading stock CFDs works, we’ll give you a simple, plastic example.
Let’s say you want to enter the market and have your eye on Microsoft shares. Let’s also say that one share is $100 (isn’t that the dream) and that you want to enter into a CFD for ten shares. So, that’s ten shares, times 100 dollars each, which equals $1,000. But, don’t forget, CFDs allow for leveraged trading, which means you don’t need the whole $1,000 but only 20% of the entire value (because the leverage is 1:5).
So, you have to deposit $200 (20% of the entire value) and have enough money in your account to open and maintain your position.
Then, you have to pick a direction. Do you think that Microsoft shares will increase in value? Then go long and open a Buy position. If you think they’ll decrease, do the opposite. Keep the position open as long as you think you should to see how the price behaves, or set up close at a loss or close at profit stops that will close your position at a predetermined price.
The Importance of Understanding the Stock Sectors
The stock market has several sectors. They structure the market and are simultaneously independent of each other, and work in tandem. Sectors and industries often move together, which is why a trader needs to understand the sectors and their connections in order to trade on the stock market.
STOCK CFDs
Stock Sectors
As mentioned, there are some common currency pairs that traders usually deal with:
- Technology — software, hardware, and related technology (such as semiconductors)
- Financial — banks, consumer finance providers, brokerage companies, insurance companies, mortgage trusts
- Energy — companies in the natural gas and the oil industry. Extraction, production, and export companies
- Industrial —machinery production companies, transportation companies, defense, and engineering companies
- Consumer discretionary — companies that offer goods and services for which there isn’t always demand (as it depends on the consumer’s financial status), such as apparel companies, restaurants, retail providers, etc.
- Consumer staples — companies that offer goods and services for which there’s always demand (independent of the consumer’s financial status)
- Basic Materials — companies that produce and export basic materials that consumer staples and consumer discretionary companies buy in order to make their goods and services
- Communications — internet, phone, and other providers as well as satellite and Wi-Fi companies
- Healthcare — companies that provide healthcare in any form
- Utilities — companies that provide gas, water, and electricity
- Real Estate — financiers, brokers, realtors, real estate developers, investment trusts that deal with real estate
Risks You Are Facing When Trading Stock CFDs
CFDs are a mellow version of high risk, high reward deal. They have a multitude of benefits, but they also come with their own set of risks. Aside from the fact that your losses can exceed your deposit, CFDs also have other risks:
- When you enter the CFD as an investor, your initial position immediately gets decreased.
- There’s a weak industry regulation, unlike with stock trading, which is highly and rigorously regulated.
- CFDs have a potential lack of liquidity, and the markets are volatile.
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