Even though there has been slow growth in CFD transactions, it still continues to attract a broad base of traders. CFD trading platforms remain the only option to trade with as lows as $25 and get free training in the process. That, plus the fact that all you need is an internet connection are the driving factors for this form of trading.
A CFD (contract for difference) is a deal between you and a provider to exchange the difference in prices of an underlying financial asset from when you enter the trade to when you exit it. The CFD doesn’t buy or sell in the physical market. Instead, it mirrors the asset’s price and is settled in cash when the trade is settled.
You can use CFDs to leverage rising and falling markets. The CFD is no more than speculation on the price trajectory of an underlying asset. Because it doesn’t involve ownership of the asset, you can make a killing even in falling markets.
Financial institutions mostly use CFDs to hedge their investments against radical market movements. With the proliferation of online dealers, private investors can also trade in hundreds of different markets and with assets such as bonds, stocks, and currencies.
Types of CFDs
Equity CFDs: These are the most popular types of CFDs. They give you a chance to trade on the price fluctuation of shares without the costs of ownership.
Commodity CFDs: These CFDs help to leverage the price movements in diverse markets such as oil, gold, and sugar. Commodity CFDs are often based on futures markets, but spot contracts may be available on silver, gold, silver, and oil.
Bonds and interest rate CFDs: Government bonds and interest rate futures can be traded with CFDs too.
FOREX CFDs: You can trade more 200 currency pairs with a FOREX CFD, from grand pairs such as EUR/USD to emerging ones such as USD/INR.
How CFDs work
A CFD often has both a higher and lower price. The higher one is the offer price, and the lower one is the bid price. When you speculate that the price will rise, you buy at the offer price. If you see the price dropping, you can buy at the bid price.
The value difference between the offer price and the bid price is called the spread. For securities, one CFD is equal to one share. For commodities, one CFD is similar to one contract of the trading asset.
Most CFD trading platforms make it easy to see the value of one CFD in comparison to the underlying market. You should source the best broker to suit your needs, you can review some of the leading options here https://www.trusted-broker-reviews.com/cfd-broker/
CFDs provide cost-efficiency
CFDs are purely based on prices; no asset changes hands. They can thus help you to avoid the costs of owning an asset, including account management and stamp duty fees. There is less capital required in this investment trading. You have the chance to make more trades and easily move between markets.
CFDs are also a tax-efficient form of trading. It is possible to offset your capital gains tax liabilities using the losses you incur in CFD trading.
Hedging portfolios
CFD contracts replicate nearly exact similar share transactions. They can help to safeguard your portfolio, especially when you predict a sell-off in the stock market. Opening a CFD on a stock that you have a long-standing position on can help to buffer against further losses.
Your CFD bid will make gains if the process continues in a downward curve. That helps to balance the stock and minimize risk and loses.
You can trade more with less money
With margin trading, you can buy more CFD positions with way less money. You will only be required to deposit a fraction of the trade size in each CFD transaction. For instance, with a CFD share trade of £1000 and with a margin requirement of 5%, you would only need £50 to open the trade position.
The benefit of this is that you get all of the gains from the trade (5% of the gained value). It is possible to amass huge profits in a short time. However, you will also be liable for 5% losses accrued in the trade. For the £1000 business, if it moves 5% in a lower, the value of the initial 5% deposit would be debited on your account.
There are risks involved
CFD trading is a high-risk undertaking. There is a potential for significant losses, especially for new beginners. The limitless leveraging potential could be both a bane and a boon. Over-leveraging is a deadly sin common with new traders. It happens when too much risk is staked on a given CFD position.
Over leveraging is a mistake commonly committed by traders looking for getting rich quick medium. Proper risk mitigation is needed to limit losses, and risk only a manageable portion of your overall trading capital position.
There are no voting rights with CFDs. You have no say in the future direction of the underlying asset. All you have to go by are the market forces and the prices they dictate. You, therefore, need to solidify your trading strategy with accurate forecasting.
__________________________________________________________
Articles you may find interesting: “What is Forex?“