CFDs, or contract for difference stocks, are one of the most popular forms of trading and are far easier to get to grips with than many people realize. The main advantage of trading CFDs is that you can make a decent profit with a far smaller initial investment than you would need to make if you were buying traditional stocks, shares or commodities. That is because you are trading on price movements without having to buy the underlying asset.
As the name suggests, contracts for difference are a contract between you and a broker to pay the difference between an asset’s entry and exit price on a given market. You will be trading on a margin, where you only need to invest a fraction of the actual value of the asset you have a contract for. Although brokers also offer leverage on other forms of trading, enabling traders to operate on varying margins, the nature of CFDs means that the margins are often the lowest available, starting from 5% of the total price of your investment. Essentially you are paying a deposit to cover any potential losses. However you can lose more than you initially paid out. This risk is inherent in all forms of margin trading.
Great flexibility
CFD trading means buying and selling a quantity of contracts for difference as though they were actual stocks. However CFDs can be bought and sold on almost any form of asset, not just stocks. This means that if a particular market, like the stock market, is experiencing an overall downturn, you can still trade CFDs profitably elsewhere. CFDs are available on over 15,000 markets, including forex and cryptocurrencies, commodities like metals and energy sources, indices and more.
Low entry threshold
You can begin trading CFDs without having toinvestmuch money at all. It’s possible to buy a single CFD on a generous margin, meaning the financial entry threshold is extremely low. It’s up to you when to enter and when to exit the contract, with the difference in value between these two points representing your profit or loss. This enables you to make a quick profit or to cut your losses if necessary, and you can start trading CFDs from your PC, tablet or even your phone whenever you like.
Make a profit even when the price drops
With CFDs you can trade on falling markets as well as rising ones. That’s because you’re trading on the price difference rather than the asset itself. You have to decide whether you think an asset’s value will go up or down, and then place a CFD order accordingly.
When a CFD appears on the market both a buy price and a sell price will be listed. By trading on the buy price, or “going long,” you’ll make a profit if the underlying asset increases in value. But you can choose to trade on the sell price instead, if you think the asset is going to lose value. If that happens, you’ll make a profit. This is known as going long. In other words you can buy a contract for the difference in price in either direction, but you need to bet on one or the other at the outset.
Hedge your position
CFDs are more flexible than traditional stocks but still follow the underlying market more closely than related activities such as spread betting. This means that you can use CFDs to hedge your position on stocks you already own by going short. If the stocks increase in value you make a profit as a stockholder and you can cancel your contract and offset your losses against capital gains tax. If your stocks dip in value you’ll make a profit on your CFDs trading on the sell price, which will help to cover your main losses. Meanwhile you can hang onto the stock if you think there’s a good chance of it regaining value in the long term. Obviously you should only do this if you have good reason to think your stocks may experience a short-term drop in value but will then recover.
Immediate results
CFD trading allows you to make a profit quickly. It’s all about short-term speculation so your money is not tied up for long periods of time. Similarly if you do lose money on a CFD trade you will need to pay immediately. This is actually an advantage because it prevents your losses from mounting up. Like bad gamblers, many novice traders dig themselves into a deeper hole thinking their luck will change. This is not an option with CFDs.
With low commissions, high leverage, easy access and great flexibility, CFDs are an ideal option for the beginning trader. If you’ve ever wanted to begin speculating on any market, this may be your best way in.