What Are CFD’s and How You Can Trade Them Online
What are CFD's? It's a question many people are asking who are new to trading online..
Many people ask the question what are CFD’s and how do you trade CFD’s online? In truth they sound more complex than they actually are, and once you begin to use them you’ll find they are easy enough to understand. However, it is a highly leveraged way of trading that comes with a significant risk to your capital. To make sure you understand what a CFD is, keep reading.
A Contract For Difference (CFD) is the process of two parties (buyer and seller) agreeing to pay the difference between the value of an asset at closing time and when the contract was made. CFD’s are popular amongst traders because they allow them to benefit from all the advantages of trading shares without having to physically own them. CFD’s are available to trade online in countries like the United Kingdom, Canada, Germany, Japan and numerous other nations but United States laws forbid the trading of CFD’s currently.
What are CFD’s? Here’s How They Started:
CFD’s first came into being in the early 1990s in the UK. Two employees of UBS Warburg, Brian Keelan and Jon Wood, are credited with the invention of this form of trading. One of the initial reasons they gained popularity is due to the fact that CFD trading was not subject to stamp tax, unlike regular trading. It was to take almost ten years for CFD’s to mushroom in terms of popularity however. This is because investors realized how beneficial it was to be able to trade on leverage. Leveraging effectively allows traders to control shares worth many times more that their initial investment. In 2002, CFD’s spread to the Australian market with dozens more nations following suit.
How CFD’s Work
CFD’s are traded online between individual investors and specific CFD companies. This form of trading allows freedom for both parties as they are no hard and fast rules though most providers follow similar sets of regulations. The entire process begins with the trader making an opening trade on a certain asset with a provider and gives them a ‘position.’ There is no specific date when the trade must be concluded so it is up to the trader to end the process. Once the contract is ended, the difference must be paid by the party who has lost on the transaction.
Each individual provider will have a set of charges relating to the opening trade. For example, traders may be subject to initial fees in the form of commission, account management fees and overnight financing. Though there is no set date when the contract ends, the trader should realize that positions left overnight will ‘rollover’ into the next trading day and will incur holding charges. The profit and loss of the contract is calculated at the end of each trading day with additional charges taken into account before the position is reopened the following morning.
CFD Account Rules
The trader is bound to maintain the minimum margin at the end of each day. This effectively means they need to have a certain sum of money in the account to cover losses incurred. For example, if you purchase a share for £200 using £40 of your money, the provider may want a minimum margin requirement of £20. In this instance, the net value of the share is £40, not £200. If the share dropped to £170, the net value is now (£40-£30 loss) = £10. This is £10 below the margin of £20. If this happened, you would have to either invest more money to cover the margin or else the share would have to sold quickly before the provider liquidates your position. In general, the end of the day’s CFD trading is called at 10pm UK time.