The first derivative that we will look at is the CFD. In form, a derivative is a contract for exchange (typically defined as “put” and “call”), stipulating that at contract time, the buyer will sell to the dealer the difference in the value of the underlying asset and its current value. It is typically traded on futures exchanges. The CFD is used as a method to hedge risks and as such provides the opportunity to profit from price changes in the underlying market because prices can move either up or down (depending on the market direction).
For CFD trading to work well, CFD trading dealers need to be both large and liquid. If the trader has significant leverage, this can be very beneficial, because small changes in prices can lead to big profits. However, small CFD trading dealers do exist, and these traders must follow certain rules in order to be legally allowed to operate. Many CFD trading platforms offer “lower margin requirements” which means that they do not require traders to use more than 10% of their account capital on any single trade.
Lower margin requirements mean that you don’t have to risk as much money upfront to start and CFD trading can be used to get a foothold in the markets even if you are only starting out with virtual funds. CFD trading offers many advantages to CFD traders but also has some disadvantages, so understanding these before you begin can help to make your transition smoother.
If you are looking for an opportunity to profit from price movements in the financial markets without the risk of holding shares or commodities, then CFD trading is ideal for you. You can speculate on either direction of the market and, because CFD trading is essentially short term trading, you are able to make the trades when they occur. The great thing about this, is that if the market moves against you lose money, then you can always un-purchase or trade back in the following period and this way you won’t lose as much money. This kind of flexibility means that it is both suitable for speculators and investors who want to make quick money without having to be locked in to a particular financial instrument for an extended period.