A CFD is a leveraged financial instrument based on another publicly traded financial asset. CFD certificates can be based on stocks, commodities, currencies and indices.
The term CFD is an abbreviation that stands for Contract for difference. CFD certificates are popular among day traders due to the fact that they make it possible to make large profits from small market movements. CFD:s makes it possible for the day trader to make a living from their trading even if they are not fabulously rich. CFD certificates makes it possible to make the same profit from an investment that you would have made investing a lot larger amount directly in the asset the CFD is based on.
You buy 2000 shares of stock A. You buy them at $100 a piece. You invest a total of 200 000. The stock quick increase in value to $102 and you decide to sell the stock. You get 204 000 when you sold the stock. You made 4 000 in profit on your 200 000 investment. A 2% return.
Your friend make the same trade but instead of buying the asset directly he buys a CFD based on Stock A. The CFD has a x20 leverage. He invest a total of 10 000 in the CFD (the cost of 100 shares) and thereby gets the same exposure as you did when buying 2000 shares. He chose to close his position when the stock hit $102. Your friend also earned 4000 on the trade. (100*2*Leverage(20)= 4 000)
Your friend made 4 000 profit on a 10 000 investment. A 40% return.
The CFD allowed your friend to make the same profit as you even though he invested a lot less money. This is how CFD certificates allow day traders to make large bets even if they do not have a lot money. By using CFD:s they can expose themselves to a larger market position without having to invest large sums of money.
CFD certificates is a powerful tool that can allow you to make very large profits. The flip side of CFD certificates is that you can also lose a lot of money. They are very high risk financial instruments. You can lose more money then you initially invested when you are trading CFD certificates. It is even possible to lose more money then you have in your account. If you do then you are liable to deposit more money to cover the loss in your account. European legislators are working on new legislation that would limit your loses to the money you have deposited into your account but it makes takes years for that legislation to be enacted. Until then you risk unlimited loses when you are trading with binary options.
Most CFD brokers will make a margin call and close your position if the money in your account is insufficient to cover your position but they have no obligation to do so and they might be unable to do so in a quickly moving market.
Never leave CFD positions unattended and make sure you understand the risk before you start trading with binary options.
The leverage used when trading with CFD:s can vary greatly between different brokers. Some brokers offer certificates with very high leverage while others offer lower leverage. It is also very common that brokers will offer higher leverage on CFDs based on some assets than they do on CFDs based on other assets. Currency based certificates are often available with very high leverage while the leverage for stock based certificates is a lot lower. Higher leverage makes it possible to earn and lose more money.
The European union want to limit how high leverage the brokers are allowed to offer to retail traders.