How does investing in CFDs work?

CFD stands for ‘contract for difference’. Investing by means of a CFD is just that little bit different. But what is a CFD and how does investing in CFDs work? You can read all about it in this article!

What exactly is a CFD?

CFD stands for contract for difference which is a so-called derivative. When you invest in a CFD you do not trade directly in, for example, a stock. No, in CFD trading you enter into a contract with the broker to trade in a particular security. You can bet on a price increase as well as a price decrease.

How does investing in CFDs work?

You can invest in CFDs at an online broker. Click here to open an account with an online broker. CFDs track the price of an underlying security. You can use CFDs to invest in, for example, shares, commodities and currencies. To open an investment position, you must choose one of the following options:

  • Buying: you obtain a positive result when the price goes up.
  • Shorting: you obtain a positive result when the price falls.

The difference in price between the moment you open the position and the moment you close your position determines your result. When you buy a CFD stock for $5 and you close the position at $10 you achieve a $5 profit per stock. However, you do not own the stock itself, you only trade in the underlying asset. You can read more about how the profit and losses works with CFD trading here.

Investing in CFDs

Leverage with CFDs

It is possible to use a leverage for CFDs. Leverage makes it possible to open a larger investment with a small amount of money. In short, it allows you to invest with money that you do not deposit yourself. However, the results you achieve are entirely yours. You can read more about the exact operation of the leverage here.

With a CFD, the broker therefore covers the major part of your investment position. Fortunately, this does not mean that you can lose more than your deposit. Thanks to the so-called margin call, your positions are automatically closed when there is not enough money left in your account.

But how can the broker let you invest by means of leverage? They can do this because they normally hedge the positions. This means that they take an opposite position. As a result, the broker (almost) never loses money on the position. However, they do make money by calculating a so-called spread. The spread is the transaction cost, you can read more about it here.

How CFDs work

You now understand the basics of investing in CFDs. When you are ready, you can open trading positions in stocks, commodities and index funds, among others. The difference between the buying and selling price then determines the profit or loss.

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