Hi there,
I've been reading quite a bit about CFDs and CFD trading and here is my understanding of the concept. I just wanted to confirm what I've understood is really what CFD trading is!
- In a nutshell, when someone trades CFDs, they trade nothing, no underlying asset or anything. Zilch. They are simply betting whether the price of a stock will go up or down. For example, the stock price for a share of Company A is £1. Mr. Z decides to buy 1000 shares of Company A for £1000. So he does so via a traditional broker.
Now comes Mr. Y. He wants to buy the same amount of shares, but he doesn't have the money. So instead of paying £1000, he goes to a CFD provider who provide him with 1000 imaginary shares of company A for only £20 at a 2% margin.
If stock price for one share of company A goes up by 2%, then MR. Z makes £20 worth of profit.
In the case of MR. Y, he too makes £20 worth of profit - albeit with a lower initial investment.
However, in the case of the price of stock falling by 10% - then MR. Z looses £100 of his £1000. Whereas MR Y looses his £20 and would have to pay £80 to the CFD trader.
Here is where I get a bit confused: why does MR.Y have to pay £80 to the CFD provider? I mean is it's not as if the CFD provider went out of their way to actually buy the underlying stock? They don't even need to have the ability to buy the actual stock - they just need to assure MR. Y that, for a 2% margin, his £20 has the same purchasing power that Mr. Z's £1000 has. Therefore, his trade should simply close once the price of Company A has fallen by 2%.
To put things in another term: my friend tells me that she only has £20 but wants 1000 shares of company A as she believes the share price will go up. So I tell her, you can't afford 1000 shares with £20, but if you give me £20, I will make sure that you get the profit that you'd make as if you had 1000 shares. So price goes up by 1%, she closes this imaginary trade and I give her £20 profit. But if her bet goes against her, I don't actually have to charge her £80 extra for her being wrong? I won't even have to keep her £20? I only need to have the ability to pay her the profit.
Am I making any sense, or have I misunderstood something?
Also, I do understand that there is a buy and a sell price for CFD stock. Where exactly is the sell price coming from? The buy price can easily be the price of the stock, but where exactly the sell price is coming from? For currencies I suppose this is the exchange rate of one currency against another, but what about for stock?
And speaking of currencies, can they only be traded on CFD provider platforms? Apart from obviously going out and for instance buying euros with pound, hoping that in the future the price of euro will go up against pound, allowing for profit to be made.
And one more thing: Company A has only 2 publicly available stocks. In a traditional sense, this means only 2 individuals can own the stocks. Whereas in CFD trading there is no limit to the number of people who can trade CFDs for this asset as nothing is actually being purchased, right?
Sorry about the long post!
I'd really appreciate your help.
I've been reading quite a bit about CFDs and CFD trading and here is my understanding of the concept. I just wanted to confirm what I've understood is really what CFD trading is!
- In a nutshell, when someone trades CFDs, they trade nothing, no underlying asset or anything. Zilch. They are simply betting whether the price of a stock will go up or down. For example, the stock price for a share of Company A is £1. Mr. Z decides to buy 1000 shares of Company A for £1000. So he does so via a traditional broker.
Now comes Mr. Y. He wants to buy the same amount of shares, but he doesn't have the money. So instead of paying £1000, he goes to a CFD provider who provide him with 1000 imaginary shares of company A for only £20 at a 2% margin.
If stock price for one share of company A goes up by 2%, then MR. Z makes £20 worth of profit.
In the case of MR. Y, he too makes £20 worth of profit - albeit with a lower initial investment.
However, in the case of the price of stock falling by 10% - then MR. Z looses £100 of his £1000. Whereas MR Y looses his £20 and would have to pay £80 to the CFD trader.
Here is where I get a bit confused: why does MR.Y have to pay £80 to the CFD provider? I mean is it's not as if the CFD provider went out of their way to actually buy the underlying stock? They don't even need to have the ability to buy the actual stock - they just need to assure MR. Y that, for a 2% margin, his £20 has the same purchasing power that Mr. Z's £1000 has. Therefore, his trade should simply close once the price of Company A has fallen by 2%.
To put things in another term: my friend tells me that she only has £20 but wants 1000 shares of company A as she believes the share price will go up. So I tell her, you can't afford 1000 shares with £20, but if you give me £20, I will make sure that you get the profit that you'd make as if you had 1000 shares. So price goes up by 1%, she closes this imaginary trade and I give her £20 profit. But if her bet goes against her, I don't actually have to charge her £80 extra for her being wrong? I won't even have to keep her £20? I only need to have the ability to pay her the profit.
Am I making any sense, or have I misunderstood something?
Also, I do understand that there is a buy and a sell price for CFD stock. Where exactly is the sell price coming from? The buy price can easily be the price of the stock, but where exactly the sell price is coming from? For currencies I suppose this is the exchange rate of one currency against another, but what about for stock?
And speaking of currencies, can they only be traded on CFD provider platforms? Apart from obviously going out and for instance buying euros with pound, hoping that in the future the price of euro will go up against pound, allowing for profit to be made.
And one more thing: Company A has only 2 publicly available stocks. In a traditional sense, this means only 2 individuals can own the stocks. Whereas in CFD trading there is no limit to the number of people who can trade CFDs for this asset as nothing is actually being purchased, right?
Sorry about the long post!
I'd really appreciate your help.
