CFD Trading: Why Does the Value of CFDs Go Up and Down?

The stock market has undergone a spectacular revival over the past 12 months, recovering well from the initial impact of the global meltdown. Many of the individuals that are making profits from the stock market are doing so using Contracts for Difference (CFD) trading, rather than purchasing shares outright.

Until fairly recently, the vast majority of trading on the stock market was done via brokers, with individual investors passing their business through the brokerage. However, internet technology has allowed the investor to have more choice on how to interact with the stock market. Individuals can now operate and maintain their own accounts via virtual brokers, receiving no advice and paying a minimum level of commission.

Such execution-only stockbrokers process your transactions according to your instructions. Because there is no human interaction and no advice given, the cost of processing those transactions is far cheaper. Of course, such trading should be undertaken only by individuals who can afford to lose their investment and are confident in their knowledge of stocks.

People buy shares in the belief that the underlying company will both grow and generate profits, thereby adding to the overall value thereof. However, if it is anticipated that the company will face financial hardship or some other obstacle, then investors will often offload or sell their shares before the value falls excessively.

Rather than actually buying shares outright, there is also a secondary market known as CFD trading. CFD trading enables an individual to benefit from rising stock prices without the need to buy the share itself.

If you are tempted to begin CFD trading, it is essential that you understand how the prices of CFDs fluctuate.

When buying CFDs you are not actually buying stock in any company. You are buying a contract that is based on the value of a particular stock. Using Apple as an example, were Apple’s share price to rise then the value of a CFD based on Apple will similarly rise. Conversely, if Apple’s share value was to fall after the purchase of a CFD, then the contract’s value would similarly fall. CFDs are directly tied to the value of a stock, leading many people to question why investors don’t just buy shares instead. The answer is that you can use leverage to improve your investing returns. Instead of having to pay the going rate of a stock, you can pay a percentage. This can be as little as five per cent.

Whilst leverage creates the potential for the realisation of greater percentage profits from high-priced shares, it also works in reverse; any fall in the value of a CFD can prove very costly indeed. If you do decide to dabble in CFDs, make sure you do so wisely!