CFDs basics
What is a contract for difference (CFD)?
A contract for difference (CFD) allows traders to speculate on underlying assets, such as stocks, indices, or commodities, without actually owning them. Instead of purchasing the asset, the trader enters into an agreement to exchange the difference in the asset's price from the time the contract is opened until it's closed.
With CFDs, you can benefit from both rising prices (opening a long position) and falling prices (opening a short position). Additionally, CFDs offer the ability to trade on margin. This allows you to open positions larger than your available capital. This leverage can magnify your potential profits but also increases the risk of significant losses.
Example
Consider an initial investment of $1,000 with a leverage of 1:10. The underlying asset price is $100 per share, allowing you to purchase 100 shares, resulting in a total exposure of $10,000.
If the asset price increases to $110 per share, the total value of your position becomes $11,000. The profit would be $1,000 ($11,000 - $10,000), yielding a return on investment of 100% ($1,000 profit on $1,000 initial investment).
Conversely, if the asset price decreases to $90 per share, the total value of your position drops to $9,000. The loss would be $1,000 ($10,000 - $9,000), resulting in a loss on investment of 100% ($1,000 loss on $1,000 initial investment).
Check this FAQ to learn more about CFDs terms and definitions.