Contracts for Difference (CFDs) are financial trading derivatives. These give individuals the opportunity to trade using borrowed money from a broker, to support their efforts when speculating on the price movements of a security.
A quick look at CFDs
There is no need to own the underlying asset, as you will be entering a contract that focuses on the difference in value between the opening and closing prices of trades, which is known as the spread. There are a host of pros and cons when considering any form of trading, so let’s take a look at what you can expect from CFD trading in particular.
As this article is focusing on the benefits and pitfalls, if you want to learn more about these contracts in general or are asking what are CFDs, you can click here for more information.
What are the advantages of trading CFDs?
1. Trade both rising and falling markets
One of the biggest pros of CFDs is that individuals can speculate on both rising and falling markets, increasing the potential of trading twofold. When going short (speculating price declines in an asset as opposed to rises), there are no restrictions such as expiration dates to be considered. This means that you can take up positions and exit them at any time. This is further supported by no shorting costs, so you won’t have to worry about any hidden fees.
2. Leveraged trading
As leverage is used with CFDs, it can be an affordable way to get into trading and gain some worthwhile insight into the wider environment. As you will only need a margin sum to get leverage, you will be able to enter more expensive trades or potentially take up more positions. It may be worthwhile to keep in mind that brokers set margin percentages themselves and often require traders to have a minimum amount of assets before contracts can be undertaken.
3. Invest in a wide range of markets
Unlike many forms of trading, there is a wide range of financial markets that can be traded on when using the right brokerage. In many instances, individuals will be able to access CFDs for Forex, shares, bonds, indices, commodities, ETFs and more – all from a single account.
4. Technology provides some worthwhile assistance
There are a host of automated trading tools that can be utilised when CFD trading. You can use AI to enter and exit trades on your behalf, as well as to help with market insights and more. With many platforms supporting mobile functionality, you can even set the parameters you want on the go.
What are the disadvantages of CFD trading?
1. Leverage is a disadvantage as well as an advantage
If leveraging seemed too good to be true, that’s because there is a downside when using it to trade. While the required margin may be low and the profit potential increased, the potential for losses is also enlarged. The first consideration with this is that losses are calculated across the entire spread and not just the individual’s portion of the trade. Next, if you open a position undercapitalised and overleveraged, you could potentially lose your entire investment with the smallest market price movements. In the event of things not going your way, you may get a margin call, which will require you to either close all of your open positions or add more funds to your account. If you owe money to your broker and don’t perform either of these tasks, your account will be closed automatically and you could lose the ability to trade with them in the future.
2. Long-term costs can add up
On the face of it, CFD trading is affordable and accessible to a host of individuals, but if positions aren’t managed properly or are left open for extended periods of time, there can be costs added on that could mount up over time.
3. Volatility in CFD trading
As with any trading endeavours, the financial markets can be volatile and any changes can affect the spread of the bid and the ask prices with little to no warning. It’s advisable to practice trading on a demo account to get used the environment of trading CFDs. Ensure you research the market you’re trading and monitor world news and current affairs.
Final thoughts on CFD trading
When the risks of CFD trading are fully understood and strategies put in place to minimise losses, there is a lot to like about it. It is accessible, has plenty of potential and can be a more cost-effective way to trade.
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.