What is online CFD Trading?
The contract for difference (CFD) trading is a form of financial derivative that allows you to trade on the price movement of financial assets, without actually owning the assets. The financial assets used include currencies, shares, indices, commodities, and treasuries. The popularity of CFD trading has grown widely over the past decade following its numerous benefits to traders.
How does CFD Trading Work?
First, you do not buy or sell any underlying assets. The trading is based on CFD units. Therefore, while trading you buy or sell CFD units for a given asset depending on whether you think the price of the asset will rise or fall.
In addition, the concept comes in two strategies, which are:
- Long Position
Long position is where you ‘buy’ the units of a particular instrument. By buying, it means you are betting on the value of the instrument to increase within the life span of the contract. If the prices of the financial asset move in your favor, you will gain CFD units of the instrument you have bought.
- Short Position
On the other hand, Short Position is where you predict that the value of given assets will decrease within the period of the contract. This means that you will ‘sell’ CFD units of the asset. In case the value of the asset increases, then you will suffer a loss. Usually, losses are calculated by subtracting the opening price of the instrument from the closing price of the instrument within the contract period.
How Much Do You Need To Invest?
Although the amount of money needed to start varies with different CFD brokers, it is mostly quite affordable. Other than that, if you are a beginner at this technique, it is highly recommendable to trade with brokers that have CFD demos. This will help you acquire trading skills quite fast.
Reach the markets with leverage, but know your risk!
CFD Trading is popularly known as a leveraged product. This means that it has a low margin requirement. That is, by investing very little amounts, you have the potential to maximize your returns. While else trading on the margin may maximize your profit, it may equally maximize your loss. Thus, it is important that you become fully comprehensive with leverage nature of CFD Trading before investing.
Why CFDs let you earn more
- A Variety of Trading Options
CFD Trading uses various financial assets, also known as instruments for trading. The assets include shares, currencies, treasuries, commodities, and sector. Traders that deal in different assets are all covered if they wish to invest in CFD Trading.
- Negative Balance Protection
In case of a loss, CFD trading has ensured that you do not lose more money than what you had deposited in your account. This regulation came into action around mid-2018 and it is effective for brokers regulated by the EU. Therefore, do not worry about overboard losses in case of any loss. However, this does not rule out the possibility of losing a trade.
- No Shorting Rules
While shorting is accepted in CFD Trading, some markets prohibit it. Such markets require you to borrow the asset before shorting it or meet a certain margin requirement. However, with CFD Trading, shorting can be done at any time and there are no regulations and requirements to be met. This is possible since the trader does not own the financial assets.
- Professional Execution with No Fees
Many CFD Brokers do not charge an additional commission fee when a trader pays the spreads. When buying, the trader pays the asked price only and when selling, they pay the bid price. However, this does not apply to CFD Shares.
- Hedging Potential
This is a risk management approach that enables you to offset potential losses. If your trade is not progressing as you intended, you can open an equivalent trade in the opposite direction. This is popular, especially for short positions.
Disadvantages of CFD Trading – read these!
On the flip side, although CFD is a popular profiting trading technique, it has its drawbacks. They include:
- Poor Regulation
Firstly, note that it is an over the counter market. Unlike centralized markets, CFD Brokers are not efficiently regulated. The reliability of a broker is based on its reputation, financial position, and longevity rather than the government standing, which is more reliable. Therefore, it is important to double-check your CFD Broker before investing.
The leveraging nature is a double-edge sword. While it may grant you large amounts of profits, it also exposes you to potentially large losses. On that account, it is not always a bed of roses.
Cost of CFD Trading
The following are the costs of:
- Spread– this is the difference between the bid price and the asked price.
- Market data fee– this is a market data subscription fee paid to view price data for share CFDs.
- Commission– when trading shares, you must pay a separate commission. This cost is only for shares.
- Holding cost– this is a cost subjected to your account if there is an open position after a trading day usually at 5 pm New York Time
In summary, the above mentioned are features, advantages, and disadvantages. Therefore, if you have been toying with the idea of investing, now you are fully informed, and you can choose what’s best to start with.