A Contract For Difference or CFD is an agreement which allows a professional market trader to make a profit (or loss) from variations in the price of the CFD. The price of the Contract For Difference is determined by an underlying reference instrument (which could be any tradeable security made available by your CFD broker such as a share on the stockmarket, a metal on the commodities market or a currency on the forex market.).
More often than not, CFD brokers and dealers automatically provide a free stop-loss order service to their trading clients. This is to encourage people to limit their losses on this very risky leveraged trading instrument. A stop loss on your CFD is exactly that, a tool for the trader to limit their trading losses. It is up to the trader to self regulate their usage of this tool and any trader is encouraged to utilise the tool in their trading systems.
Depending where you are trading Contracts for Difference (CFD) in the world, there are a few common features of these leveraged trading instruments.
Let’s use a case study to illustrate how CFD’s (Contract’s For Difference) work. So lets take Australian listed Woodside Petroleum (WPL) and assume the price is at $50. After our technical or fundamental analysis we have decided whether we want to sell (going short) or buy (going long) the stock (or the CFD). Say we go long (buy the stock) and decide to risk $1 on each point of fluctuation in Woodside’s share price.
If you’re looking into trading CFD and have been doing your due diligence before playing with fire, you would definitely have heard from someone that CFD’s are risky. Super risky. And they aren’t too far from the truth. They are. So you need to be super careful when you do start trading CFD’s. So why are CFD’s so risky?
CFD is the abbreviation of Contract for Difference. And that’s exactly what it is, a contract for the difference of the value of the underlying equity or security. Very simply put there are two parties, you the trader and the broker, provider or dealer. You (the trader) initiate the CFD deal with your dealer by buying long or selling short a certain security. The security can be anything such as stocks listed on the US Dow Jones or the Australian Stock Exchange or any currency traded in the foreign exchange (forex) markets.
So here you are reading the CFD Trading Frequently Asked Question (FAQ) page. I’m sure if you’re a CFD n00b (net speak for newbie) you’ll find this page very helpful.