This article is written by freelance writer Zak Goldberg.
If you’ve grown tired of the traditional currency trading or stocks and shares investments, where you simply buy low and sell high, you may be looking for a new type of trading opportunity. Contract for difference (CFD) trading could be the answer. It’s great way to expand an existing investment portfolio and vary the types of trades you make, which is advisable if you wish to increase your chances of profiting or hedge against risk. Here’s how CFD trading is unique and reasons for whether you should consider it or not.
How Does It Differ from Other Trading?
A contract for difference is the difference between where a trade is entered and exited. It is a derivatives product, which means that unlike when investing or trading stocks and shares, commodities or other assets, you do not actually own the underlying assets directly. This means that essentially the contract is an agreement between you and a broker.
The other main way that CFD trading differs is that you can profit from falling as well as rising markets. There are two options, to go long or short. If you think an asset will rise in value then you buy or go long, whereas if you believe it will drop in price then you sell or go short. However, if the markets don’t go the way you predict then you will still experience a loss.
For example, if you think Microsoft’s share price will drop in value you go short on Microsoft share CFDs. Here you are not directly investing in the shares so do not need them to rise to make a profit. Instead, profits will increase in line with a fall in price below your opening level. If they rise you suffer a loss for every rise in price though.
What Can I Trade?
Products in most of the global markets are offered by the majority of brokers for CFD trading. This means that if you already specialise in one area then it is easy to continue trading in the same market, with the ability to profit from falls in asset prices.
It also means that you can trade across a wide variety of markets, at different times of the day when certain ones are open. A great opportunity to expand your trading portfolio and diversify exists through CFD trading. Everything from forex and indices to shares and all sorts of commodities can be traded.
Are There Any Benefits?
Compared to traditional trading, CFD trading offers much higher leverage, starting from as low as a 2% margin requirement. Depending on the asset, this can go up to 20%. This requires less starting capital from investors to make big trades and profits for those who are successful.
As a derivative product where you do not own the underlying asset, you do not have to pay stamp duty either. Depending on the broker you use, there aren’t always charges or fees to pay, as they make money as the trader pays the spread. This can make it a cheaper option than some other trading types.
And the Disadvantages?
In the same way that you can make large profits with the increased leverage available, it can also magnify losses. For this reason, it is still important to use stop losses to ensure that you do not lose too much should a CFD trade not go your way. It is also hard to profit from small moves in the market as you have to pay the spread. The CFD industry is less well regulated, so it is vital you check the broker is reliable before making trades through them.
On the whole, CFD trading offers a new and exciting way to make trades, covering most global markets and allowing traders to profit in different ways.