CFD is a form of derivative trading that enables you to speculate on the rising or falling prices of various tradable instruments, such as indices, treasuries, commodities (i. e. gold, silver, gas, oil, wheat, oat, soybean, cotton, coffee), shares, currency pairs (Forex) and more.
As a part of OTC (over-the-counter) trading that is a form of decentralized market without a central physical location, CFDs are different than commonly known forms of trading such as futures.
What differs CFDs from centralized exchange is that you do not own the physical stock, but you trade on the difference in price between where you got in and where you got out.
Before you start trading, you have to find out about advantages and disadvantages of CFDs.
What are the advantages of CFDs?
- You can go short or long – which means you can both sell and buy assets (instruments). When prices are moving up, you can first buy and then sell an asset (go long); when prices are moving down, you first sell and then buy (go short). Many traders choose so called ‘short positions’ to protect their long positions – this is known as hedging.
- No stamp duty – as CFDs are an agreement between you and your broker, you do not have to pay UK stamp duty.
- Leverage – it is a key feature of CFD trading. It enables gains and losses to be multiplied so it is both an advantage and a disadvantage of this type of trading. Using leverage means that you need only a small percentage of the full value of the trade you want to open. That amount of money is called margin and it makes CFDs attractive to traders who do not possess large capital. But leverage carries risk of losing even more than margin so before you enter the market, you must be entirely sure what you sign up for. Because of the inherent risk, CFD trading may not be suitable for all traders.
- Low costs – when trading CFDs you have to pay the spread which is the difference between the buy and sell price. Many brokers such as CMC Markets offer competitive minimum spreads and margin rates on their assets.
- There is no expiry date to CFD what makes it very liquid.
- Trade hours – unlike on centralized stock exchange, with CFDs you can trade day and night, almost 24 hours per day between Sunday and Friday.
- Diversification – you can trade on global markets and have access to many various instruments. An ability to trade across different markets will help you diversify your trading portfolio.
Every trade should also be aware of the disadvantages. There aren’t many, but you have to know them.
- As mentioned above, leverage can be both – the advantage and disadvantage of CFD trading. The higher leverage, the higher risk – that’s why beginners should avoid high leverage, because even a small change in the market can have a big impact on your money and you may suffer serious losses.
- Volatility – in financial markets prices are prone to move quickly and unexpectedly, driven by politics, economic news, natural disasters etc. These movements can bring you extra profit but also can result in losses.
- Over-trading – low capital requirements sometimes may lead to over-trading which can result in losing control on your open positions. The more positions you have opened at the same time, the higher risk of losing control.
CFD trading is certainly worth recommending to traders who are looking for new trading opportunities and who are keen to trade on other assets than just currencies.