CFD Trading Hedging

Before going ahead with CFD trading or using it for hedging, you should have a thorough understanding of the concept and the terms that your are going to use. CFD comes from “contracts for difference”, meaning a contract between two parties, one that buys and one that sells, in which the difference between the value of an asset at the contract time and at the current time must be paid by the seller.

The difference of asset value from the two different moments stated in the contract may be positive or negative and depending on that the seller pays to the buyer or the other way around. Using CFDs trading, one can speculate on financial instruments which one doesn’t have to own. Each CFD can have particular contract terms in accordance with the needs and interests of the trader or CFD provider. However, there is one thing all CFD agreements have in common: both seller and buyer need to fix the volatile commodity price.

Let’s have a look at what “hedging” means. Hedging, related to Finance, refers to  covering risk. A trader buys instruments in one market in order to offset the risk of price fluctuations in a different market. A very simple type of hedging techniques is the insurance policy. Futures contracts are another hedge instrument that is commonly used. Let’s take a farmer for example. The farmer’s profit depends very much on the demand of wheat when the harvest cycle ends. When the demand is high, the profit is also high and the other way around. If the farmer signs a futures contracts which specifies a certain price, then the farmers is insured in case the wheat is sold at a low price. However, by signing this contract, the farmer has no longer the right to sell the wheat higher than the established price, so the buyer of the wheat benefits from this situation. It depends on the market conditions which party makes profit, but there is a benefit for both parties in that that the risk of the volatile commodity has been mitigated.

How can one use CFD trading for hedging?

There is a constant risk in the market regarding the value of financial instruments in general and of share in particular. Many investors are not sure about the right moment to cash in. They usually wait until the very last moment, when they feel the share price is dropping too much. CFD trading is a way to solve this problem. If they want to avoid the risk of their shares price going down, the solution is to take a short position CFD. In case of the price of the share going up, all they have to do is covering the difference. If the price goes down, then they get back the difference, so they don’t lose, but they don’t make profit either. This means that in this particular case of shareholding they are “hedged” against volatility. All they need to do is to enter an opposite and equal CFD position to what they currently have in shares. This way the prices movements are neutralized.

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