The Financial Term CFD Explained

The core definition of a CFD and the concept of CFD trading are underpinned by a very basic principle, a contract.

A contract for difference, also known in the abbreviated form as a CFD is an agreement to exchange the difference in value of an asset. The value or potential profit of this asset lies in pricing. Profit can be made from this agreement when the difference between the opening price and closing price is realised.

CFD trading has experienced rapid growth during these recent times of economic uncertainty as volatile markets provide traders with the perfect opportunity to take advantage of the increased leverage it offers. CFDs allow traders to not only profit from the rising value of a share but to also profit from a decline in value. A trader may choose to ‘go short’ in order to profit from falling share prices or to ‘go long’ and profit from rising share prices.

Another reason why CFDs are popular is because they provide an ideal method for ‘hedging’ your portfolio. A trader purchases 6,000 real shares, but wants to hedge this investment. In order to hedge the purchase of 6,000 real shares; the trader must sell the equivalent through a CFD at the same price.

CFDs are a unique financial instrument, with features which allow traders to play the markets from a different perspective. In addition to hedging your portfolio, CFDs provide investors with a gateway into the global financial markets, inviting traders to move beyond their native markets and into a greater choice of shares, 24 hours a day. Along with greater choice comes increased market exposure in terms of capital. A contract for difference allows traders to be exposed to markets for a significantly lower cost than if you were purchasing physical shares. Inevitably this does also mean that you can experience losses which are larger than your initial investment.

A contract for difference can provide reassurance in the form of hedging and increased market exposure for limited capital. As with all trades, CFDs need to be considered in the context of the market place but a willingness to look beyond the boundaries of conventional physical shares can at times lead to a greater reward.

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