Let’s start this guide by defining what CFDs are and what features make them suitable for online trading. We will start with the technical definition and then explain it in a simple way, so that it is clear in all its aspects, even for those approaching CFDs for the first time.
Definition of CFD
CFD stands for Contract For Difference, which in British is translated into Contract For Difference, is a financial instrument in which two parties agree to exchange money based on the change in the value of an underlying asset from the time the transaction is initiated to the time it is closed.
The underlying asset can be for example a share (such as Ferrari shares), or a currency exchange (such as EUR/USD), a commodity, an ETF, a stock exchange index and more.
The definition seems rather complicated, but we are now trying to simplify it and make it more comprehensible for practical purposes.
What are CFDs, explained simply
CFDs are financial instruments whose price is derived from another financial instrument, the underlying asset or underlying asset. If the price of the asset varies on its market, so does the CFD. When trading CFDs, the broker provides CFDs that the trader (the user) can trade by opening long or short positions depending on whether he wants to trade up or down.
Let’s go back to the definition, the step that says you agree to trade money based on the change in value of an underlying asset. Well, if the trader thinks that the change in value will be upward, he will be able to make long transactions, also called buy transactions. To the contrary, if the trader thinks that the variation of value will be to the decrease, it will be able to carry out short operations also said of purchase.
The trader, therefore, will buy or sell in function of the variation of price that he thinks will register the Stock at the closing of the operation. To better understand what CFDs are, it is necessary to understand well the concept of opening and closing.
Opening and closing a CFD position
We always keep in mind the definition of CFDs: we agree to exchange money based on the change in the value of an underlying asset from the time the transaction is initiated to the time it is closed.
Let us now consider the part concerning opening and closing: what does this mean?
It simply means that the contract is based on two poundamental moments:
- Opening: this is the moment when the operation actually starts with all the conditions contained in the contract. The transaction, once opened, starts to affect the available capital in terms of profit and loss.
- Closing: is the moment when the transaction actually ends, terminating all the conditions contained in the contract. The transaction, once closed, no longer affects the available capital.
The trader, i.e. the user, must therefore take into account that from the moment the CFD opens the position (i.e. the moment it initiates the trade) it will continue to produce profits or losses until the moment it closes the position.
For this reason, the choice of when to open the position will be dictated by the expectation that a certain price will move up or down in order to open buy or sell positions in order to make a profit.