CFD is an acronym for Contract for differences .it is a contract between the broker and the trade to exchange the differences in the value of a financial instrument between the time the contract opens and closes. CFDs are innovative financial derivatives that provide investors exposure to numerous markets and financial instruments.
CFDs are traded on margin, that means they use a high level of leverage. some brokers offer up to 1:500 leverage. When trading CFDs the traders are required to invest only a small fraction of the total position and the CFD broker covers the rest. It is one of the reasons which makes CFD Trading attractive, but the high leverage has also a downside, traders may lose much more than their initial deposit. Some people even compare CFD trading to “borrowing money to gamble”.
Let us assume that the asking price of ABC stock is $30 and the trader decides to purchase 100 shares. The total cost of this transaction is therefore 3,000. If the trader is using 1:2 leverage he would need to pay $1,500 upfront for the trade.
However, when trading ABC stock with a CFD broker, the leverage is significantly higher – around 1:20.This requires the trader $150 up front. This is one of the many benefits of trading CFDs over traditional methods.
If ABC stock appreciates and the bid price reaches $31, the trader would be able to sell it for a total profit of 100. In percentage terms, the profit is 6.67%. By using a 1:20 leverage the yield will be much higher.