With CFDs you don’t have to own a stock or commodity, you however speculate on a certain market, trade using margins and profit when the market goes according to your prediction.
If you’re just hearing about CFDs for the first time, relax and sit tight. We will highlight every single detail you need to get started with CFD trading.
Before we delve further, we need to know what a CFD is.
What Is a CFD?
CFD is an acronym for Contract For Difference. It is one of the most popular investment tools in the financial market.
CFDs give investors the opportunity to trade on the price movement of any financial market. With CFDs you can trade commodities, stocks, indices and currencies without owning the underlying assets you’re trading. The Contract For Difference is made between an investor and the broker. You can trade CFDs on exchanges just like stocks and cryptocurrencies, but unlike cryptocurrencies and exchanges, you don’t own the asset.
CFDs are amazing investment tools. With this trading method, you can make profit/loss when the market is rising or falling, you can use your capital more effectively with the leverage effect. Transaction cost is low with CFD trading, and you can trade 24/7.
In the next section, we will talk about how CFD trading works and how you can trade CFDs.
CFD Trading – How to guide
Trading CFDs can be a game-changer for every investor keen on making most of their capital. Trading CFD isn’t as easy as it sounds, so you’ll need a lot of education to succeed. Let’s say you’re planning to invest in company ABC. ABC produces heavy-duty truck tires.
Say you’ve noticed business has been booming recently for company ABC and you strongly believe ABC shares will go up in price. What is the best way to profit from the price increase? First, you can buy ABC shares and wait till their value grows to an excellent position.
However, if the price increase is just minimal, it isn’t worth the risk. There is another option for traders; they trade CFDs.
You can predict the price of the share to go up; we call this “longing” the market. You can also predict the price of ABC shares to drop. Here, you can trade your CDs of ABC shares; we call this “shorting” the market.
With CFD trading, you earn a profit/loss when the market is falling or rising. The significant thing about trading CDs is this: if the market moves towards/away from your predictions, you make more profit or loss.
It’s not all rainbows and sunshine with CFD trading. You can also lose your investment. If the market doesn’t go in favor of your prediction, your investment runs at the risk of a potential loss.
Another benefit of trading CDs is what we call margins. With margin trading, you don’t have to pay the full value of the position, you only have to pay but a fraction of the position and earn your full profit.
In the next section of this article, we will go into the full details of margin trading and how smart investors like yourself can benefit from this lucrative investment vehicle.
What is margin trading?
Margin trading allows you to secure more positions than you normally would at a fraction of the price. Trading using margins uses the leverage effect to help investors subsidize their capital.
This is how margin trading works. Let’s say Tesla stocks are trading at $10. If you predict Tesla stocks are about to rise in price (Maybe because of a tweet from Elon Musk), you purchase 2000 CDs on Tesla stocks at $10 per stock.
Let’s assume Tesla stocks have a margin rate of 10%. This simply means you have to deposit just 10% of the value of the trades just as in your position margin.
If you calculate this: 2000 CDs at $10 is $20,000. 10% of $20,000 is $2000. This means your position margin is $2000. You only have to deposit $2000 to purchase 2000 CDs of Tesla stocks.
If your predictions come true and Tesla stocks start trading at $15 per stock, your 2000 CFDs multiplied by $15 are now worth $30,000. This means you’ve made a profit of $10,000 in your position by just investing $2000 in CFDs.
You can replicate the same process when you predict a market is going to fall. You short the market and leverage on the margin provided. But like I said earlier, sometimes your predictions can go wrong and you lose your capital.
What is leverage?
Leveraging in CFD trading is akin to margin trading. With leveraging, they exposed you to a large position without having to pay the full cost of the purchase. If we use the example of the Tesla stocks we talked about in the previous section, say you wanted to open a position equal to 100 Tesla shares. With a traditional stock purchase, you’ll have to pay the full cost of the purchase, with CFD leverage effect, you might pay just 10% of the cost. Depends on the leverage available on that stock.
Leveraging allows you to maximize your capital. It is an investors’ dream. However, keep in mind that they calculate your profit/loss on the full size of your position.
Leverages determine the profit you earn or the losses you have incurred. That’s why investors are advised to pay enough attention to the leverage ratio and make sure you’re not risking your capital just to make a quick grab.
Advantages of CFD Trading
CFD trading has its advantages, some of them include:
Global Market Access From One Platform
You can get 24/7 access to all the major markets across the world with CFD trading. Many brokers offer access to blue-chip stocks like Apple, Google, and Amazon, top trading commodities like Gold, Silver, and Natural Gas. Major indices like FTSE 100, Nasdaq 100, and S&P 500.
With CFDs you can get higher leverage than you’ll get with traditional trading. The standard leverage for CDs is subject to the industry regulations, but can get as high as 50%. A lower margin means less capital outlay and higher returns with higher leverage giving investors the opportunity to magnify their profit or losses.
No Day Trading Requirements
The traditional trading market is fraught with regulations for day traders. Some markets require a certain amount of capital before you can secure your position while some require your type of accounts before you can make trades. CFD trading doesn’t work within these regulations. All account holders can day trade anytime they want. Accounts can be opened with as little as $1000.
No Shorting Rules or Borrowing Stock
The CFD market doesn’t conform to shorting rules because a CFD trader doesn’t own the asset. You don’t need to borrow the instrument before shorting or get subjected tk different margin requirements for long or short positions when trading CFDs.
Disadvantages of CFD Trading
CFD trading also has its disadvantages. Some of them include:
The CFD market isn’t adequately regulated. This means brokers credibility depends on word-of-mouth referral, longevity, and reputation rather than government assurance and liquidity.
CFD Trading is a high risk, fast-paced financial trading market. When trading CFDs, you have to be on high alert as your positions can be closed by your provider if you no longer meet certain requirements.
Traders pay the spread
While the traditional market pays the spread but spreads your profit through fees, regulations, commissions, and higher capital requirements, CFD trading reduces capital by allowing the traders to pay for their spreads.
Traders have to pay for the spread for entry and exit positions. This means you can’t make enough profit if you decide to make a quick and small trading move.
Can I trade CFDs without leverage?
Some brokers allow you to trade without leverage while some insist you do. It all depends on your broker.
Is CFD Trading risky?
There are some levels of risk involved when trading CFDs. You need to be on top of your game and extremely vigilant when trading CFDs.
Can I trade CFDs in my country?
Some countries like the United States are exempted from trading CFDs. You can ask the broker if your country is allowed to trade before you register with them.