CFDs uncovered: Why you should consider trading CFDs

Julie Brownlee, Fsp Invest, 02 Oct. 2014

Tags: cfds, what are cfds, contracts for difference, why trade cfds, trading cfds, cfd,

Contracts for difference (or CFDs) are financial derivatives products.

What this basically means is the value of a CFD derives itself from the value of something else. In the case of CFDs this is usually shares and indexes.

So what exactly are CFDs? And why would you opt to trade them?

Let’s take a look…

What are CFDs?

CFDs are over the counter derivatives. What this means is you don’t trade them through an exchange like you do shares.

Instead of trading them through an exchange, a market maker provides CFD trading. This could be a dedicated CFD trading company or one of South Africa’s banks.

A CFD trade is an arrangement between two parties to exchange the difference between the closing price of the contract and the opening price of the contract.

Unlike other derivatives, one CFD contract equals one underlying share. With single stock futures, one contract equals 100 underlying shares.

Why trade CFDs?

There are a number of reasons why you might opt to trade CFDs.

One reason is to trade CFDs to hedge against your current investment portfolio. For instance, if you hold shares in Sasol and you expect the share price to fall, you could short (sell) Sasol CFDs to protect your position.

The other reason is to trade CFDs for pure speculation. For example, you expect shares in Sasol to rise, so you buy Sasol CFD contracts.

As CFDs are geared products, this means if the trade works the way you envisage it, you stand to make a decent profit from the rise in Sasol’s share price.

But with all financial derivatives, there are risks.

Because CFDs are geared products, this leverage magnifies any movement in the underlying share price. This means you could lose a lot of money if a trade doesn’t work out as you planned.

This is why when trading CFDs you need to employ strict money and risk management techniques to try to keep your risks to a minimum.

So there you have it, why you should consider trading CFDs.

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