Investing in CFDs
A CFD (Contract for Difference) is an agreement between two parties that obliges them to exchange the difference between the opening and closing price of a position – regardless of whether it increases or decreases in value.
CFDs are derivative instruments – the prices of these contracts depend on the prices of various assets such as shares, currencies, and raw materials. They are often compared to futures contracts known from an exchange. The difference is that CFDs do not have a specific expiry date. Earnings on CFDs are similar to trading currencies on the Forex market – with the difference that in the case of CFDs it is not currencies that are traded, but shares of companies listed on stock exchanges.
It is important to remember that when investing in Contracts for Difference, we do not become owners of shares or currencies, nor do we become owners of a contract which is a material confirmation of our financial contribution to investment. We are simply given the opportunity to speculate on the future price of shares, currencies or commodities, and we trade on an upward or downward movement in their value. Our loss or profit depends on whether the prices of the good associated with the contract go in the direction we anticipate. When we bet on a so-called long position, i.e. a price increase, we make money every time the price rises and we lose when it falls. When we take a so-called short position, the opposite is true – we make a fall, we lose out on an increase in the value of the shares, currencies or commodities that our CFD is linked to.
Leveraging on contracts for difference
Leverage, or lever, is a concept inherent in earning money from CFDs. What is it?
Let’s start with the fact that by entering into a contract, we do not become owners of shares. We only need a fraction of its full value to make the transaction. So the initial investment contribution can really be relatively small in relation to market exposure. For example, when we think that the share price will rise and we want to buy a CFD in the so-called long position, a margin of only 20% of the transaction value is sufficient. In reality, this means an investment of, for example, only a few hundred, not a few thousand zlotys. Leverage can therefore significantly increase the amount of profit in relation to the invested capital, but it can also significantly increase the loss. Therefore, the key to investing CFDs is an accurate risk assessment.
Where can you invest with CFDs?
Trading in contracts for differences is possible with stock indices such as the American Dow Jones or the German DAX index. Other types of markets available for investing in Contracts for Difference are currency and crypto markets, as well as commodities. Thanks to the possibility of investing even with a very small composition, investing in contracts for differences can bring big profits in real terms, but there can also be big losses in case of incorrect risk assessment.