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What are CFDs and Derivatives?
What are CFDs and Derivatives?

A short introduction to the terms CFDs and Derivatives

The Amega Geek avatar
Written by The Amega Geek
Updated over a week ago

Two terms that every trader in the online markets must understand are Derivatives and, more importantly, CFDs (Contracts For Difference)

In this article, we will focus more on CFDs as it will help you better understand the logic and advantages of trading on the online market.

However, to better understand CFDs, we must first take a quick look at what a Derivative is.

Definition of Derivatives

In trading terms, a Derivative is a financial instrument whose value is derived from the value of one or more underlying assets, such as currencies, commodities, precious metals, etc. So the value of a derivative fluctuates according to the value of the underlying asset. For this reason, it is possible for us to trade in the price movement of Derivatives as CFDs.

What is a CFD?

CFD is an acronym for Contracts For Difference. It is a financial contract made in financial derivatives trading that pays the difference of their prices between opening and closing trades.

When trading in CFDs, we are trading on the price of an asset rather than physically buying the asset itself.

For example, opening a Buy position for 1 Lot of Oil (1000 barrels) doesn't mean that a big truck will show up outside your house and dump 1000 barrels of Oil in your living room! Since you are trading on 1 Lot of Oil as a CFD, you are simply buying the equivalent value of those 1000 barrels.

That should save you some space!

Trading CFDs gives us a great advantage, as we can make profits regardless of whether the asset's value goes up or down.

For example, let's take the real stock market:

If you were trading physical stocks, in order to make a profit, you would have to buy the stock when the value is low and sell it when the value is high.

However, if the stock's value drops after you have bought it, you either accept a loss or hope the value will eventually rise.

On the other hand, if you are trading stocks as CFDs, since you are only trading on the value of the stock, you can make a profit regardless of the market's direction. You can buy if the value is going up and sell if the value is going down.

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