When you decide to trade in the financial markets, it’s important to determine your trading profile, which includes your goals, knowledge, and available capital. This will enable you to pick the trading strategy that suits you best. You should also research individual brokerages in order to select your preferred platform for trading a range of assets and products, such as CFDs.
CFD stands for Contract For Difference. It is a financial instrument that allows you to trade on an underlying asset to take advantage of changes in its price, without owning the asset itself. CFDs are leveraged products, meaning that traders use margin trading – funds loaned to them by the broker – when taking up positions.
When a trader wants to open a position, he is expected to put a fraction of its total value aside. This small amount is called Collateral. The process guarantees that the broker can recoup some its losses if the value of a CFD position opened with margin falls below a certain level.
The system Margin is a tool that enables traders to invest more money than they have in their accounts, offering greater market exposure and the ability to open more positions. Margin trading allows traders to multiply their gains, although their risk is also increased.
Margin trading lets you borrow capital from your broker in the hope of a greater Return On Investment (ROI). You can then trade a wider range of financial assets and/or open larger positions, which allows your broker to earn bigger commission.
Let’s say you want to trade Coca-Cola stock using $5,000 in cash. Coca-Cola (KO) is now trading at $43.28, but you think it will go back up to the $46.87 value it reached on April 8th. If you are trading only with cash, rather than using margin, you would only be able to buy 115 shares (115 x $43.28 = $4,977). However, by trading on margin, you can buy 230 shares (230 x $43.28 = $10,000).
Margin Calls happen in very volatile markets, when prices change rapidly. If the price of an asset moves in the opposite direction to your position, your losses will increase. If there isn’t enough money in your trading account to cover your losses and the margin, your broker might ask you to deposit additional funds.
For successful trades, margin can result in a win-win situation for the trader and the broker.