CFD certificates are a type of financial instruments that make it possible to make leveraged trades based on stocks and other financial instruments. A CFD or a Certificate for difference is a financial instrument that is based on an underlying asset. The value of a CFD is directly tied to the value of the underlying asset. Many brokers offer bear CFD certificates that increase in value when the underlying asset loses in value.
All CFD:s are traded with leverage. How much leverage varies depending on the type of asset the CFD is based on. Stock based CFD:s usually have a leverage of x250 or less. Currency based CFD:s can have leverage that is a lot larger than this.
CFD certificates are high risk investments and you can lose more money than you have invested. You can even lose more money than you have deposited to your brokerage account. If this happen you will be liable to pay the rest of the money you lost to the broker.
How does it work
Lets pretend that you buy one CFD based on the stock of Tesla. The price for 1 Tesla share is USD100. This is also the price you pay for the CFD. The leverage of the CFD is 249x. Your CFD will in other words allow you to make the same profits and loses as you would have been able to do if you had bought 249 Tesla shares. Buying USD249 shares would however have cost you USD24 900. Buying the CFD only cost you USD100.
Lets assume that the Tesla stock goes up to USD 102. You decide to liquidate your position. You sell your CFD. The CFD is now worth USD 498 more than you paid for it. (USD 2 * 249). You have earned USD 498 which equals a 498% return on your USD 100 investment. Not bad at all.
Lets assume that the Tesla stock in stead goes down to USD 99. You decide to limit your loses and liquidate your position. You CFD is worthless because it has gone down USD 249 in value (1*249). You have also lost an additional USD 149 (outside the price of the CFD) that you need to pay to the broker.
The maximal lose that you risk when you buy a CFD can be calculated by multiplying the current value of the underlying instrument with the leverage. In the example above your maximal lose would be USD24 900. The difference between the current value of the Tesla stocks and its lowest possible value (0) multiplied with the leverage.
CFD certificates are designed for day trading and other short market position. You will have to pay a fee if you want to hold your CFD over night. How big this fee is varies between different brokers but it is usually based on the national interest plus a certain percentage. The fees are generally rather small but are despite this very profitable for the brokers.
Check with your broker to find about the overnight fees before you buy and keep CFD:s over night.
Is it a scam
CFD certificates have a somewhat bad reputation. This is completely undeserved. The reason for this is that CFD certificates are a rather new type of financial instruments and some other new financial instruments have been used to scam investors out of money. This includes binary options that I talk about in another article on this website.
CFD certificates are however nothing like these other instruments that has a reputation that is more well deserved. CFD certificate are not traded against the broker and the broker does not earn money when you lose money. This is a common misconception. The broker makes more money of you make more money and have every incentive to help you become as successfully as possible. If you hear someone claim that the broker are sabotaging their trade to make sure that they do not make any profit than you know they don’t understand how the trade work.
It is a common misconception that the broker makes money when a trader loses money but this is not the case when trading with CFD. All reputable CFD brokers will hedge your position on the open market. IE in the example we used earlier they would buy 249 Tesla stocks on the open market to hedge your CFD position.
The brokers makes their money from the spreads and the overnight fees. The overnight fees is usually the largest sources of income for the brokers. They make more money if you make money and keep trading. If you loose all your money they earn nothing.
Choosing a broker
When you chose a broker you should choose a well established, regulated broker. I recommend using separate brokers for your stock trading, your CFD trading and any other trading you do. This makes it easier to track the progress you make within each trading discipline. To use different brokers for different trades also have the benefit that you can choose to register with the best CFD broker, the best stock broker and so on. You do not have to compromise and try to find a broker that does it all somewhat well.
I recommend that you visit a number of review websites such as this one before you decide which broker to choose. Always make sure that the broker offer CFD:s based on the exact assets you want to trade with before you register an account with the broker in question.