An Introduction to CFD Trading: What Budding Traders Need to Know

The Fundamentals of CFD Trading

CFD stands for “contracts for difference.” As its name suggests, this type of trade is an agreement between the buyer and the seller. The main intention here is to generate a profit as the result of changes in the price between when a contract opens and when it closes (expires).

It should also be noted that CFD instruments are known as derivatives. This signifies that the trader will never physically own the stock or underlying asset. He or she will instead, make either a profit or loss, based upon the changes in its price within a specific period. Another interesting point is that CFD trading will not take place in any open-market exchange. The trade is executed between the trader and the CFD broker.

Another aspect of CFD trading involves the ability for profits to be accrued during both bullish, and bearish sessions. . This is one of the reasons why CFD trading can be a powerful strategy to speculate on the stock market during uncertain economic times.

What are the Benefits of CFD Trading?

Why are many traders drawn to this type of strategy? There are actually numerous benefits which CFD trading can offer. It pays to take a quick look at some of the most impressive before moving on.

Leveraged Trades

Leverage trading is associated with derivative products and some experts will argue that this is the most important advantage of CFDs. Sometimes known as margin trading, this strategy allows a trader to allocate a small percentage of the aggregate value of the asset when opening a trade. For example, let us imagine for a moment that the margin associated with a fictional stock is 5% In this case, only 5% of the total price will be needed to open a CFD.

Flexibility

Since a CFD is an agreement to exchange the opening and closing values of a certain asset, this strategy also tends to offer a significant amount of flexibility when compared to other trading strategies. In other words, traders can take advantage of rising and falling markets.

Those who feel that the markets are entering into a bearish climate will therefore place a trade at the buy price. If values are expected to fall, the CFD will be purchased at the sell price.

A Massive Presence

CFDs are some of the most accessible trading instruments in existence. The chances are high that they will appeal to a wide range of trading styles. Assets that can be traded include:

• Cryptocurrencies
• Currency pairs (Forex)
• Commodities
• Shares
• Indices

Due to the ubiquitous nature of CFDs, it is also possible to perform after-market trades. This is important if late-breaking news is expected to dramatically impact the buy and sell price of a position. 24/7 access is likewise crucial for those who may be involved with numerous different markets at any given time.

An Alignment with the Underlying Markets

In some ways, CFDs can be viewed as “mirrors” of the larger marketplace. They tend to mimic underlying trends and price movements. However, the main advantage here involves the concept of leveraged trading mentioned earlier. While it may not be possible for a trader to afford a share in Apple (for example), the chances are high that he or she could instead place a margin trade with an associated Apple CFD. So, even traders who have limited funds may still be able to take advantage of potentially significant price movements.

Balancing a Portfolio

A final benefit of CFDs involves how they can be used to create a balanced portfolio. Let us assume that a trader holds several shares in a large bank. However, the price of these shares is expected to fall in the near future. Opening a CFD position which predicts such a decrease in value can be used to offset any losses that would have otherwise occurred (assuming the prices do indeed fall). This is known as a “hedging” strategy.

Are There Any Possible Drawbacks?

It is important to remain objective when discussing any type of trading strategy. This level of clarity will then enable traders to make informed decisions at the appropriate times.

So, what are some potential pitfalls of CFD trading?

Volatility

CFD trades are associated with a certain degree of volatility. Spreads and price points can change quickly when fluid market conditions are present. If the trader cannot financially cover a dramatic reduction in value, the position itself may be closed by the broker. As a result, any money invested will be lost.

Margin Trading Risks

We have already mentioned that margin trades are excellent ways to leverage a large position. However, this is assuming that the price moves in the right direction. There may also be times when this level of exposure leads to substantial losses if the movement was not correctly predicted. This is one of the reasons why only experienced traders should become involved with margin trades.

Regulatory Concerns

The CFD markets are not as highly regulated as other indices. The reliability and transparency of a position is instead associated with the reputation and experience of the broker. Thus, it is important for traders to partner with well-established and regulated brokers.

Traders are Responsible for Paying the Spread

Finally, traders are required to pay the value of the spread* (the difference between the buy and sell price) when a position is opened. This can sometimes be problematic for those who make small moves or who are primarily interested in day trading. Such an initial fee could likewise offset any profits by a certain amount. However, this is not normally a concern for larger trades.

What Marketplaces Offer CFDs as Trading Options?

CFDs are unique since they enjoy what can only be called a massive market presence. Hence, they are available to traders around the world. An individual who may reside in the United Kingdom can choose to monitor the status of the FTSE 100 index as well as indices from other countries like South Africa 40. Here are some additional markets to consider:

• Stock indices (such as the Dow Jones, the NASDAQ and the NIKKEI)
• Forex markets
• Industrial sectors (banks, technology, oil, and gas)
• Soft commodities (livestock, sugar and grain)
• Precious metals (gold, silver, platinum, and palladium)

The sheer variety of CFDs is, therefore, beneficial for anyone who is interested in a specific sector or asset class. In the same respect, those who wish to broaden their skills can always enter a new marketplace.

Is CFD Trading the Right Decision?

The answer to this question is partially based around the desires of the trader. While there is no doubt that CFD trades offer impressive benefits, the associated risks are just as critical to appreciate. Furthermore, it is crucial to work with the latest and most advanced online platforms to maximize the chances of making a profit.

*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 this is prohibited under US regulation.