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Trading instruments uncovered: What is a CFD?

by , 01 September 2015

If you want to trade shares, commodities, indexes and currencies, you have a range of different trading instruments to pick from.

One of these trading instrument is a contract for difference or CFD.

So what exactly is a CFD? And what can you trade with CFDs?

Read on to find out…

The ins and outs of a CFD

A CFD is a financial derivative. A financial derivative is a contract which derives its value from an underlying asset, such as a share, index or currency.

A CFD is an over the counter trading instrument. This means it doesn’t trade through an exchange like single stock futures do, but through a company providing CFD trading. This company could be a bank, trading company or stock broker.

These companies are responsible for making a market for CFD to trade. They provide liquidity to the market.

One CFD is equal to one underlying share. For example, if you trade 100 Sasol CFDs, you have exposure to 100 underlying Sasol shares. This is different to single stock futures where one futures contract is equal to 100 underlying shares.

A CFD is an arrangement between you and a market maker to exchange the difference between the closing price of the contract and the opening price of the contract.

If you buy a CFD (go long), you’ll receive the difference in value from the seller if the value of the underlying share or asset rises. If you sell a CFD (go short), you’ll receive the difference in value from the buyer if the value of the underlying share or asset falls.

What you can trade using CFDs

The most common underlying asset to trade using CFDs are shares. But you can also use them to trade indexes (through ETFs), commodities and, more recently, currencies.

Many traders find CFDs an easier to understand trading instrument than others as the pricing and costs are very transparent.

So there you have it. What a CFD is.

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Trading instruments uncovered: What is a CFD?
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