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What is a CFD?
CFD stands for Contract for Difference. A CFD is an agreement between two parties to exchange the difference between the opening and closing price of a particular contract. As a derivative product, a CFD enables you to trade on live market price movements. You do not have to own the underlying instrument the contract is based on.
CFDs allow traders to speculate on market price movements. You can go short (sell), which allows you to profit from falling prices, go long (buy) in order to profit from rising prices, or you can hedge your portfolio to protect against…[read more below]
any loss in value of your investments, should the market move against you. There are over 10,000 markets to trade CFDs on, including indices, currencies, commodities and shares.
Originally developed in the 1990s, CFDs were first used on the London Stock Exchange (LSE) by hedge funds and institutional traders to hedge exposure to stocks in a cost-effective manner. In the late 1990s, CFDs were introduced to the retail markets. CFD companies swiftly grew.
Around 2000, traders recognised that CFDs could be used to leverage the value of any underlying instrument. As a result, CFD providers extended their reach to include global stocks, commodities, currencies and bonds. In 2001 CFD providers likewise realised that online trading CFDs was tax and stamp duty-free in the UK.
A flexible product, CFDs have the potential to make you money regardless of whether the market price falls or rises. CFD traders have the choice to go long if they think the market price will rise, or go short if they believe the market price will fall. Hence, if a trader thinks a company or market is about to increase in value, they can buy a CFD and profit if their prediction is correct. Likewise, if a trader believes a company or market is going to decrease in value, they can sell the CFD and still profit, should the said company or market fall in price. Should the trader’s prediction be wrong, however, he will lose money on his investment.
In volatile markets, you might decide to use CFDs to protect your existing assets, by hedging your portfolio. For example, if you own £10,000 shares in BT and you believe that value of the shares to be about to fall, you can sell the equivalent of £10,000 worth of BT shares through a CFD trade. Should BT share prices then fall by 10%, you can offset the gain in your short sell CFD trade against the loss in value of your share portfolio.
In volatile markets, it is a good idea to use CFDs to protect your existing assets, by hedging your portfolio. For example, if you own £10,000 shares in BT and you believe that value of the shares to be about to fall, you can sell the equivalent of £10,000 worth of BT shares through a CFD trade. Should BT share prices then fall by 10%, you can offset the gain in your short sell CFD trade against the loss in value of your share portfolio.