“Contract for difference” – is a contract between two parties:
the supplier of the contract and the investor (buyer of the contract) in which the seller is assumed to pay the difference between the current value (on the day of the contract) of the specific assets (e.g. shares, bonds, currencies, raw materials, goods, etc.) and their value in contract settlement date (if the difference is negative, the buyer pays this value to the seller). CFDs use leverage (so-called leverage). “
The term “contract for difference” – CFD means a contract between an investor and a broker that obliges both parties to settle an amount equal to the price difference of an asset between the contract’s opening price and its position closing.
There are several key advantages to CFDs that make them so interesting for investors:
- They allow you to invest in all categories of instruments, including currencies, stocks, commodities, funds, etc.
- They give the opportunity to earn on the increase as well as decrease in the price of each asset
- CFDs use leverage (are leveraged)
- They are derivatives
What does “derivatives” mean in the case of CFDs?
The buyer of the contract does not actually become the owner of the underlying instrument, i.e. he does not buy it literally, but only speculates whether the price of a given asset will fall or rise in the near future. Based on his predictions, he concludes a contract for difference with a broker in which he defines his position. Thanks to this solution, the investor is satisfied with only a small part of the amount that in the case of a classic stock exchange would be necessary to open a position.
Why, by investing in CFDs, can we make / or lose money on rising / or falling prices?
Because at the time of concluding the contract, the investor determines whether the price of the assets he or she is interested in will fall or rise in the near future.
If, according to his speculation, the price of the instrument rises, he takes a “long” position by choosing an option (BUY) and makes a profit every time the asset price rises.
However, if he finds that the price of the instrument will drop, he takes a “short” position by selecting an option (sell – SELL) and makes a profit every time the asset price falls.
If the asset prices move in the opposite direction to the investor predicted, he will lose his invested capital.
To better explain this aspect, we will use an example:
If an investor anticipates that their oil price will drop, they open a “short” position, i.e. sell (sell) a CFD on oil and earn as the oil price falls. Conversely, if oil prices rise, the investor suffers losses. The amount of losses and gains depends on the volume of traffic and the trading volume that occurred on the market, i.e. by how many% the value changed in relation to the price that was in force at the time the contract was opened.