Unlike traditional share trading, a Contract For Difference (CFD) is a derivative product – meaning you never actually own the underlying instrument you choose to trade on, however they still allow you to make profits or losses based on live market price movements.
A CFD is an agreement between a buyer and seller to exchange the difference in the opening and closing price of the contract.
Another benefit of CFD trading is that it is possible to make money whichever direction the markets are moving in, so you can benefit from both rising and falling markets. With CFDs you can go long (buy) or short (SELL) or use as a way to hedge your share portfolio against losses.
In order to illustrate this, consider the following example of short selling CFDs.
The value of this CFD trade at open = 1000 CFDs x 100p = £1000.00
The value of this CFD trade at close = 1000 CFDs x 51p = £510.00
Your total profit from this CFD trade was: £1000.00 – £510.00 = £490.00
CFDs are leveraged products so unlike shares you do not need to pay the total value of the contract in order to trade. Most CFD brokers will quote a certain initial percentage margin you need to deposit in order to open a CFD trade. This means you could potentially magnify the return on your investment, however higher leverage can also result in losing more than your initial deposit so make sure you learn more about leverage here.
There are many markets which you can trade CFDs in: shares, indices, forex and commodities are just some examples.