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What are CFDs?

CFD is the abbreviated term for a contract for difference. A CFD is a contract between two parties to exchange the difference between the entry and exit price of a financial instrument.

CFD traders can invest on domestic and global shares as well as foreign exchange, indices and commodities.

Because CFD's are derivatives, you never own the physical share or commodity, instead you either profit (or make a loss) on the underlying share price movement as the CFD mirrors the price of the underlying security. As a result of never actually owning the security, you are not entitled to any voting rights.

As well as buying a CFD (going long) with the view that it may rise, you can also sell a CFD (going short) that you do not own, with the view that it may fall.

CFDs are as simple as shares to trade. They trade at the same price so calculating profits and losses is identical to shares. The major difference is that you buy a CFD with borrowed money. Providers let you leverage on a CFD trade so they are traded on margin. Generally 5 to 10% of the securities value is required and the remainder can be borrowed.

Money and risk management are two skills you will need to master. You will also need to carefully manage your interest costs, losses and margin calls to ensure these do not rise above your original deposit.

To reduce your risk it is strongly recommended that you use stop-losses when trading CFD's. These are orders, set at a pre-determined price at the beginning of the trade, that will trigger a sell when the CFD passes through this set price. It limits the extent of your losses to some degree.


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