What are CFDs
A contract for difference (CFD) is a derivative and its price is based on the underlying market price of an asset, such as an equity, a commodity or an index. CFDs are traded between individual traders and CFD providers. Any positions that are left open from one trading day to the next will be charged a certain overnight fee, also known as a ‘rollover’.
With CFDs trading, you trade on the change in an asset’s value, without ever actually owning that asset.
A CFD gains or loses value as the difference between the price of the underlying asset when you buy the CFD and the current price fluctuates.
Unlike straightforward equity trading, CFDs are a leveraged product. When trading, therefore, you provide only a small deposit to access a larger portion of the market. Please bear in mind, however that although leverage may enhance your profit if the trade goes your way, it can also lead to far greater losses if the trade goes against you.
CFDs are not permitted in the United States, due to U.S. Securities and Exchange Commission restrictions regarding over-the-counter (OTC) financial instruments.
Why CFDs
There are a number of reasons to trade CFDs.
As you are trading with leverage, you can benefit from short-term fluctuations in the price of an equity or an index. Small fluctuations in the market, therefore, can yield profits. Leverage can also help you trade in equities that you may otherwise not be able to afford, as in our example listed above.
You can trade in a variety of instruments that are listed on a number of different international markets from one account.
By trading from one account you can price in charges and commissions, which vary from market to market.
As a CFD is based on the price difference, you can easily take advantage of short selling in a falling market.
Trade CFDs responsibly
You need to use the power of leverage wisely. On the one hand, if a trade is going to your advantage, you stand to make a nice profit for a small amount of money. However, if the trade goes against you and if you are using high leverage, then even a small fluctuation in price difference can put you out of the trade.
CFD trading has increased in popularity over the last decade because they offer many key advantages:
Convenient global access. CFDs aren’t regulated like other exchanges, so CFD brokers can offer access to any global market across a single, simple platform.
No trading fees. Unlike other assets, you don’t need to pay any commission or stamp duty.
Variety of options. You can buy and sell stock CFDs, but there are also lots of other options. Index, currency, treasury, commodity, and even sector CFDs are available.
24/7 access. Unlike more restrictive markets, CFD trading isn’t exclusively completed during business hours.
Incredible potential. You can significantly increase your portfolio’s potential by utilizing leverage when trading CFDs, up to 1:50.
HOW A CFD WORKS
When you trade a CFD, you aren’t buying or selling a physical asset. You’re guessing on whether you believe the price for that asset is going to increase or decrease in the future. This is why the CFD market is much easier to access and fees are non-existent.
One difference you need to be aware of when trading CFDs is the spread. The spread is the difference between what you pay and the market value – and it will fluctuate a bit among each broker. If the spread is $1, for example, then your asset must appreciate $1 before it reaches the breakeven point, and then you will begin earning profits on any further gains.
Ideal Investments
CFDs are perfect for investors who demand a bit of flexibility, which is one of the reasons they’re so popular. If you’re busy working during the day trading hours, for example, you might not have the ability to buy and sell stocks the way you’d like to.
For the investor who wants to stay organized, CFDs are also a great option. You’ll be able to do all your trading with a single broker and still have access to an enormous global market. You won’t run the risk of having to trade across several platforms and letting an opportunity slip past you.
Finally, CFDs are great for people who want to invest heavily in an expensive asset, but don’t have the capital to do so. You can purchase more shares at a fraction of the cost and without any commission fees.
Trading CFDS Effectively
Like any trading market, you need a solid strategy to trade CFDs for a profit consistently. Here are some of the most common strategies employed by successful traders:
Hedging. If you have long-term investments that you believe are due for a downward spell, shorting with CFDs could be a cheaper alternative to selling your shares and purchasing them again.
Short-term trades. CFDs are the perfect market in which to make short trades because there aren’t any stamp duties and you can trade on a margin.
Trading pairs. If you notice that one company is trading far less than it should compared to another one, CFDs are a great way to exploit it. You can make a profit by using CFDs to short the overvalued company and go long on the undervalued one.
Setting a stop-loss. Setting a hard stop-loss is vital if you want to protect your capital as you trade CFDs. Trading on leverage magnifies your wins, but it accelerates your losses as well. You need to be careful about mitigating your risk and pulling the plug before losing a large chunk of your bankroll.
It’s important to remember that CFDs are a contract between the investor and the broker. You need to work with a broker that you know and trust.