CFD trading is increasingly becoming popular due to the numerous benefits it offers. It is all about speculating on the price movements of different markets, including indices, shares, and commodities.
Whether you want to hedge existing equity or your priority is diversification, CFD trading can be an ideal choice. It offers high flexibility and helps you generate a substantial amount of money, even from a small change in the market.
Here is a detailed guide on everything you need to know about CFD trading.
How CFD Trading Works?
Before entering the volatile market, it is essential to know what is CFD trading, and how it works. A CFD is a financial derivative product, and understanding how it works in the market is not as easy as it seems. To make a successful CFD trade, you have to analyse various factors, as even a minor oversight can lead to costly losses.
In CFD trading, buying a particular stock does not mean that you actually buy the shares of the underlying asset. Keep in mind that you just entered into a contract with a broker on the basis of how the price of that particular asset will go in the future. In simple words, it is the process of speculating on the price movements of different assets without owning them in reality.
Understanding the Concept of Margin and Leverage
Leverage is one of the most powerful features used by most CFD traders. By utilising it in the right way, you can control a larger position size than your actual account balance normally permits.
Let’s suppose your account balance is $2,000. With leverage of 1:20, you can control a CFD position worth $20,000. However, keep in mind, this can lead to both amplified profits and magnified risks. That’s why you should be careful and use leverage strategically.
Leverage comes with a condition that you must maintain an essential balance in your account. Otherwise, you cannot hold a leveraged CFD position. This is known as margin, and its requirement is expressed as a percentage of the total position value you want to hold in the market.
How Underlying Asset Impact Leveraging When Trading CFDs?
When you use leverage in CFD trading, it significantly amplifies the effect of price changes of the underlying asset. It means there are increased chances of both your profits and losses.
Leverage is expressed in terms of ratios like 1:10, 1:20, or 1:50. This gives you the idea of a multiplier effect on your investment. In simple words, with 1:20 leverage, you are holding and controlling a position which is worth 20 times your invested funds.
How to Hedge with CFDs?
Hedging is an advanced strategy used by many traders. It is not as easy as it seems. You require the right tools for it, such as CFDs, to go short.
In CFD trading, to offset the potential risks of one investment, you can take out another investment. This is how many traders hedge with CFDs and protect their accounts from costly losses.