CFD stands for contract for difference, which means that both parties agreed to pay the price difference on the asset. The underlying assets refer to the cryptos, share, commodity, or index. It acts as the foundation for the contract.
How Does CFD Trading Operates
The process here is quite simple. The contract happens between the traer and the broker. Say the trader thinks that the financial market’s value increases. They start with a position to purchase CFDs, then they go long. And when the price of the asset rises, the trader will take the profits. In the same way, when the trader foresees that the value of an asset will fall, they will sell the CFDs or go short.
Then again, when the trader forecasts the movement of the market wrong, they should accept and endure the losses.
The Pros of CFD Trading
CFDs are leveraged financial tools, meaning, you just have to deposit a portion of the total value of the trade. This is what is referred to as initial margin.
Assume that your broker has 1:20 leverage for the instrument chosen. For you to start a $20,000 spot, you only need to deposit $1000.
Contract for difference is a financial tool which is more flexible, compared to the traditional ones like commodities and shares. A falling market can be an excellent opportunity for CFD trading.
Once you open a trading platform, you will see two buttons which say Buy and Sell. Sell means that you are going short in the market. In other words, you will sell it, you borrow it, then purchase it back to exit the trade.
The motivation in short selling is the expectation that the price of an asset will fall, letting you buy it back at a lower value to profit.
No Stamp Duty
CFD products are intended to trace the underlying market. When you purchase CFDs on a specific company shares, you will not be investing directly in the company or even possess its shares. You just have to speculate on the fluctuations on the price.
The Cons of CFD Trading
Oddly, the main benefit of CFD trading which is leverage, also happens to be its main downside. The use of leverage means that a small starting deposit will lead to greater exposure. The moment you leverage the position of your investment, you significantly increase your potential earnings as well as potential losses.
If the market did not go your way, and the level of your margin touches below the agreed level, your broker will give you a margin call, asking you to either deposit more cash, or partially or fully close the positions. Short sellers are prone to potentially unlimited losses because the value of an asset can infinitely grow.
These are the interest rates that you need to pay for keeping overnight a leverages position. It is computed based on the value of the CFD and is deducted everyday for every day that you keep an open position.
Lack of Ownership
Again, CFDs are not about buying the assets, but speculating on the changes of the price. Meaning, you have the possession of the contract, and not the currency, are commodity or shares.
In conclusion, CFDs are financial tools with innate advantages as well as disadvantages. Take them into consideration and be very careful before embarking on CFD trading.