How does CFD trading work?

CFDs are bought or sold directly. In this way a trader can potentially profit from either a rising or falling price action. CFD trades can be classified as very flexible. Affordable prices and a variety of asset classes are also great advantages. It is an ideal tool for short-term trades. This is mainly related to the increased volatility and liquidity of CFD products.

If the price of an asset rises and a trading position is closed, the CFD seller or counterparty has to pay the difference between the current share price and the price at the conclusion of the contract. If the price tends to fall, the buyer pays the difference in price to the seller.

Those involved in the trade are exposed not only to the potential for large profits but also large losses, so all traders should assess their tolerance for potential losses before engaging in derivatives trading.

Leverage

It is possible to use leverage when trading CFDs. CFD instruments are leveraged financial instruments, in other words, they are traded on margin. This means that we can open a new position by compounding a small amount of the total value of the position, thus meeting the broker's predetermined margin requirements.

Example:

A client has $1,000 in their trading account and uses 1:10 leverage, allowing them to buy shares/commodities/Forex via CFDs with a total value of $10,000.

Due to the higher leverage, it is essential for active CFD traders to apply sound risk management principles.

Leverage can also be called a double-edged sword as it is a risky instrument. In the case of CFD trading, it allows us to benefit from lower margin and gives us the ability to open positions well in excess of our cash. Keep in mind that this type of trading can lead to significant or complete losses of the amount invested.