Have you been keen to become involved in the world of online trading? Are you curious to learn about some of the methods that can build a financial “nest egg” for the future? If so, there are many options at your disposal. One interesting strategy is known as CFD trading.
What are the fundamental principles behind this approach? Why is it often chosen by traders? Are there any potential downsides and if so, how can these be managed? If you hope to learn more, we have put together useful information below
What are Contracts for Difference?
CFD is an abbreviation for “contract for difference”. What exactly is a CFD? A CFD position involves an agreement (or contract) between a broker and the trader. They are obligated to exchange the difference in value associated with an underlying asset after a predetermined period of time has elapsed. Let’s take a closer look at a theoretical trade to better understand these points.
What Does a Typical CFD Trade Involve?
We will now imagine that an trader is interested in the price movement associated with the fictional firm “ABC”. In this case, he will enter into an agreement with a CFD broker. This contract will include the current value of the asset as well as where it is predicted to move within a set time frame. However, a caveat needs to be mentioned.
CFD trades are not only used in the event that the price of an asset is expected to rise. They can also be employed during bearish conditions (when the value is expected to fall). Traders simply have to accurately predict the direction in which the price is anticipated to move. So, it is possible to accrue a profit even in the event that the value drops significantly.
CFDs are also a form of derivative trading. This signifies that the trader will never physically own the asset itself. The only main concern involves directional price movements. For instance, let’s imagine that an investor cannot afford to purchase gold as a holding. In this case, he or she can simply speculate on whether the price per troy ounce will rise or fall through the use of a CFD.
What are the Main Advantages of CFD Trades?
One advantage that is often cited by experts involves the cost-effective nature of this strategy. So, how much money do you need to start CFD trading? The only real requirement is to meet the minimum threshold set by the broker. Of course, these limits will vary between providers and should be determined well in advance. Let us now highlight some other important benefits to highlight before moving on.
Low Margin Requirements
Leveraging has become a powerful tool within the world of online trading. A margin trade signifies that only a small percentage of the total value of a position needs to be deposited. Thus, a trader will not be forced to outlay a significant amount of capital. This type of leveraged trading can result in higher potential returns.
A Comprehensive Ranges of Assets
CFDs are associated with a wealth of asset classes. So, they are suited for a wide range of traders and trading styles. This also signifies that even those who do not possess a great deal of financial liquidity can reap the potential rewards. Here are some assets that can be purchased as CFDs:
- Forex positions
- Exchange-traded funds
Whether you wish to Forex trade the GBP/USD pair or you are interested in the recent performance of a certain commodity, the options are quite impressive.
Access to Out-of-Hours Trading
Due to the thousands of different CFD instruments, this type of investing has gained a truly international presence. Many tradable assets are also listed on numerous exchanges. This provides traders with 24/7 access to the markets; ideal when snap decisions need to be made at the appropriate times. Out-of-hours trading is likewise useful in the event that losses incurred by a certain holding need to be offset by short-term gains associated with a CFD position.
Profits on Rising and Falling Markets
Similar to other approaches such as spread betting, CFD positions can be used within positive and negative economic climates. This is once again due to the fact that the investor simply needs to correctly predict where the value of an asset may be headed. Such an option is not possible with standard stock holdings, as a decrease in price may lead to substantial losses. CFDs are immune to such this type of situation as long as the analysis proves to be accurate.
Are There Any Possible Drawbacks?
Transparency is one of the keys to success within the financial community. This is why it is necessary to disclose some potential risks to take into account. What challenges might traders face on occasion?
The Downside of Leveraged Trades
We have already seen that margin (leverage) trading can result in substantial profits due to low initial deposit thresholds. However, the other side of the coin must also be highlighted. In the event that the position does not perform as expected, significant losses can mount within relatively short periods of time.
The Possible Effects of Market Volatility
CFD positions can change quickly on occasion due to underlying market conditions. Those who do not pay close attention to the value of their holdings could very well find that the associated margin requirements have not changed. In the event that the total equity of the position falls below 50 per cent, the trade may be automatically closed.
Slippage takes place when the price of the filled order is different than the initial price that was requested. Although this might sometimes work in favour of the investor, it could also result in an initial loss (known as negative slippage). Slippage can occur during periods of high volatility or if a certain asset lacks liquidity.
Choosing the Most Reliable Trading Platform
The good news is that the majority of the risks outlined above can be mitigated with the help of a robust and cutting-edge trading platform. For example, well established regulated brokers provide traders with a host of innovative utilities including:
- Advanced charting capabilities.
- Real-time price monitoring.
- More than 11,500 tradable instruments.
- Automatic limit and stop orders.
- Asset watch lists.
- The ability to access market sentiment.
Of course, some of these options might be unfamiliar to novice traders. This is why it is always wise to speak with a professional in order to address any additional questions. This also brings us to the final section of the article.
Frequently Asked Questions
Let’s summarise by taking a look at a few important questions.
Is CFD Trading Considered to be Safe?
Like any investment, there are certain risks associated with CFD trading. These risks can be offset by employing various stop loss or trailing stop loss strategies.
Can Investors Make Money by Trading CFDs?
There is always the potential to turn a profit through the use of contracts for difference. This is even more relevant when margin trading is employed. Still, remember that losses can and will occur from time to time.
Is it Possible to Trade CFDs with a Smartphone Application?
A growing number of investors are looking to access their accounts while out and about. Reputable CFD platforms will always offer smartphone applications that provide all of the same instruments associated with a traditional website.
How Can I Find a Trustworthy CFD Trading Platform?
It is first important to ensure that the website in question is regulated by the FCA (Financial Conduct Authority) if you happen to live in the United Kingdom. Other metrics to examine include the number of tradable instruments offered, the types of charting capabilities, the levels of customer support, and how long the company in question has been in existence.
CFD Trading: Adding Another String the Financial Bow
Some individuals pursue CFD trading only on occasion while others employ these instruments on a full-time basis. Thanks to the flexile nature of CFDs, both options are realistic depending upon your ultimate goals. Whether you are hoping to create a lucrative side hustle or you instead wish to reallocate profits into an existing pension plan, a host of possibilities await.
Of course, the chances are high that you may have additional questions or concerns. When in doubt, feel free to speak with a trained professional. He or she will be capable providing additional insight and advice that can point you in the right direction.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
*Marketing for CFDs and spread betting is not intended for US citizens as prohibited under US regulation