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Transcript
Hey, I’ve got 3 letters for you – CFD.
If you want to know what CFD is all about and what you can do with it – then this is the video for you.
CFD stands for Contract for Difference, and it’s one of the most popular ways for online investors to trade assets like stocks, indices, commodities, and currencies, because it allows them to trade these assets without actually owning them or investing large sums of capital.
CFD trading is a method of trading the value of an underlying asset, as opposed to the asset itself.
What happens is that the trader and broker enter into a contract where they agree to exchange the difference between the price of an underlying asset at the opening and closing of the trade.
First, the trader opens a position on an asset offered as a CFD, with the opening price set by the broker.
Then, if the position closes in profit, the broker pays the trader for the difference, and if it closes at a loss – the trader pays the broker for the difference.
You may also ask yourself: “Why should I use CFDs?
Well I’ve got one word for you: leverage!
Want to buy a company which its share price cost $500?
With CFDs you can apply leverage, and use a smaller proportion of your available capital to open a position of the same size.
For example, if you invest $100 in a position and apply 5x leverage, the total size of your position is $500, and as such, the profit or loss will be calculated accordingly.
Plus, you have freed yourself $400 to invest in other assets, and that’s another bonus of leveraging.
Leverage can be applied from 2x to 30x depending on the asset class.
Note that using leverage requires a high level of involvement, so it is advisable to monitor your portfolio more frequently.
The second reason to use CFDs is short selling.
Short selling simply allows you to take advantage of downward price movements in the same way you would benefit from going ‘long’.
For example, if you believe Google is expensive and that the price will go down, you can open a ‘short’ trade. This allows you to profit in the event that the instrument’s price indeed goes down.
Any financial investment involves risk, and CFDs are no different.
Trading CFDs means you do not own the underlying assets. If your equity level falls below the required minimum, your trade will close automatically and you will lose all of your initial investment.
On eToro, for example, you can invest in any asset without applying any leverage. However, when trading CFDs with leverage, it is important to bear in mind that any losses, as well as profits, will be calculated according to the total size of your position and not the capital invested.
In other words, if you invest $100 in a position and apply 5x leverage, the total size of your position is $500 and, as such, profit or loss will be calculated according to the latter sum.
Using CFDs with leverage and going short on a position are some of the most popular tools used by traders. Discover some more tools and expand your financial knowledge here at the eToro Academy.
See you in the next video!