The world of CFD trading may appear like a dark forest to some in comparison with familiar financial trading options. This is an attempt to explain this form of trading and point a way through that forest. It can hold great rewards for those who are willing to venture in and find their way around.
What is CFD Trading?
CFD is the abbreviated form of the term ‘Contract for Difference’. In a nutshell, CFD trading is a form of online trading in currency, stocks or other commodities. In CFD trading, a trader wins or loses the difference in value of an asset or share, from the time of entry into a contract to the time of exit from that contract. The trader invests without actually owning the asset. Payment is in cash, rather than in actual possession. This form of trading has its distinct potential as well as risks.
Aspects of CFD Trading
This type of online trading is tax-free in many parts of the globe. This might explain its popularity, despite being a recent addition on the scene. Rather than being a standardised form of online trading, some may term it as a type of speculation. Because of restrictions on this form of trading in Canada and the USA, CFD trading seems to be less popular in north America. It has a greater acceptance level in Europe and Australia.
Popularity of CFD Trading
It is possible to trade CFDs in micro-lots, which is another advantage. This creates yet another reason reason why a trader doesn’t need a huge financial outlay to speculate. It seems that many clients enjoy the adrenaline rush and excitement which this type of trading generates. It gives the excitement of watching or participating in one’s favourite sport. Many people compare this type of trading to betting activity. The returns on CFDs can be considerable, due to greater leverage.
Risks Involved in CFD Trading
The increased leverage in CFD trading can prove to be a double-edged sword which cuts both ways. In short, the risks involved are higher. The trader can end up losing more money than there is in the trading account, in a worst case scenario. It is, thus, advisable to consider all the risks as well as potential advantages before deciding to invest in this exciting yet unpredictable trading venture.
Necessity of Experienced CFD Brokers
As with any other type of trading in financial markets, it is wise to turn to professional brokers with a solid reputation, to facilitate participation in CFD trading. Major players in the field include CMC Markets, which gives traders access to global markets.
How CFD Trading Differs from Traditional Financial Speculation
There are certain significant differences between stock trading and CFD trading, which are worth careful consideration.
- There are lower trading costs for CFDs.
- CFDs allow the trader access to more markets from one trading account. There is increased leverage, which gives more freedom to speculate.
- CFD trading affords the opportunity to gain financially through short-selling when the market is falling. One must be a skilled trader, or have access to the services of an experienced broker.
- CFD brokers offer a stop loss facility, which safeguards against potential disaster. The increased leverage which CFD trading affords creates a situation of irresistible temptation for some unfortunate speculators. Some may throw caution to the wind and get carried away, thereby losing more than the amount invested. Guaranteed stops provide reassurance.
- In certain regions of the global market, CFD trading dividends are tax-free, which enhances its acceptability.
- There is no time expiry with CFD shares, unlike with other investment options. This is another factor which contributes to the growing popularity of CFD trading.
There is obviously much to think about when making a decision to pursue CFD trading. Traders with smaller amounts of capital would definitely prefer to indulge in this type of trading. This is because of the increased leverage it offers, the tax benefits and the absence of time expiry. But traders must exercise caution with the extra leverage, which can backfire and cause great losses.