“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). “
Some time ago investing in the stock exchange was only available to businessmen who thoroughly analyzed complex charts and turned millions of capital, investing in commodities such as natural gas, oil, gold or shares of major companies, e.g. Microsoft, Apple, Facebook, etc. At that time, the most successful were economists who knew the laws governing the international market and carefully analyzed the political and economic situation of all significant countries. On the basis of acquired knowledge, they tried to anticipate asset price fluctuations in advance.
Currently, thanks to short online training, new investing strategies available on the internet and YouTube guides, even novice investors who do not have any economic knowledge and do not spend time analyzing the market are very successful on the stock market. Only one thing remains the same… to be able to earn large amounts on the classic stock exchange, we need to have investment capital of hundreds of thousands or millions of dollars, because the price difference on which we earn is small. Most often, asset value difference are at the level of a few percent, which means that we earn a few percent of the amount invested, which is why large investment capital is very important.
In the case of the classical stock market, we are forced to risk huge capital in order to have a chance for good earnings, the slightest investment error can cause the loss of huge amounts of money, if you invest in CFDs, it is different, because in their case much smaller amounts are sufficient thanks to the use of financial leverage.
The term “exchange rate contract” – CFD means an agreement between the investor and the broker, which obliges both parties to settle the amount corresponding to the price difference of a given asset between the opening price of the contract and the closing of its position.
There are several key advantages of CFDs that make them so interesting to investors:
- They allow investing in all instrument categories, including currencies, shares, commodities, funds and cryptocurrencies.
- They give you the opportunity to earn on the increase as well as the fall in the price of each asset
- CFDs use leverage (they are leveraged)
- They are derivatives
What does the term “derivatives” for CFDs?
The buyer of the contract does not actually become the owner of the underlying instrument, i.e. does not literally buy it, but only speculates whether the price of the asset it will fall or rise in the near future. Based on his predictions, he concludes a differential contract with a broker, in which he defines his position. Thanks to this solution, only a small part of the amount is sufficient for the investor, which in the case of a classic stock exchange would be necessary to open a position.
Why by investing in Contract For Differences can we earn on rising and falling prices?
Because at the time of entering into the contract the investor determines whether the price of the assets he is interested in will fall or rise in the near future.
If, according to his speculation, the price of the instrument increases, it takes a “long” position by choosing the option (BUY) and makes a profit every time the price of assets increases.
However, if it finds that the price of the instrument will fall, it takes a “short” position by choosing the option (SELL) and makes a profit every time the price of assets falls.
If asset prices change in the opposite direction to what the investor expected, he will lose his invested capital.
To better explain this aspect, we will use an example:
If the investor predicts that the price of oil will fall, he opens a “short” position, i.e. opens a contract for the sale of CFD oil and earns on falling oil prices. However, if oil prices rise, the investor will suffer losses. The amount of losses and profits depends on the volume of traffic and the number of transactions that took place on the market, i.e. on how much the value has changed compared to the price in force at the time the contract was opened.
The opportunity to earn on buying and selling, and the fact that CFDs are leveraged makes them more attractive to many investors than ordinary shares. However, there are some risks associated with them, on the Internet you can find a lot of negative opinions about brokers and statements in which investors warn against the insolvency of some trading platforms. Choosing a good broker to invest our capital is a key issue, it must be completely trustworthy because we entrust our money to him. That is why we thoroughly tested the 28 most popular international trading platforms and we selected 15 of them that deserved to be awarded in the Brokers Ranking CFD.