A CFD (contract for difference) is a financial arrangement that is essentially a contract between a buyer and a seller. It is a renowned form of derivative trading. Such agreements enable the buyers to purchase an asset at the price difference between its current market value and its value at the beginning when it was placed on the market. Among financial investors, CFDs are quite popular because they allow traders to take advantage of profits in various markets without actually having the ownership of the assets being bought and sold.
CFDs are easily accessible, and quick. They can also prove to be profitable at times when the market is declining due to their ability to be traded for a long or short period.
The Pros of CFD Trading
There are various benefits to trade in CFDs, as mentioned below:
No ownership required
CFD trading does not require an individual, engaged in the trades, to actually own the asset that is being sold or purchased. For many people, this is a huge plus point because it doesn’t require people to invest large sums of money in a multitude of physical properties to simply earn profit from general market sales.
Traded on lower margins
CFDs are a leveraged product that is traded on margin. It enables traders to enhance the capacity of the investments made, and experiment with their money in other flourishing markets. The minimum amount required to be paid initially by the trader is 5% of the CFD to open a position. It is a meager amount when compared to the traditional share margins. This makes CFDs affordable for novice traders.
Traded for Short and Long
CFDs are able to be sold long or short positions. Short position selling enables the traders to sell the asset immediately in order to make a profit before the occurrence of a drastic decline in the market. While long position selling enables traders to hold on the asset for long in hopes of a considerable increase in its value over time. It is this versatility in long or short position trading that makes CFDs potentially lucrative for many traders.
Accessibility to global markets
CFD trading renders you greater accessibility to a broad range of markets. Such access would not be available to the retail investors otherwise, all from a sole trading platform. You can speculate on the falling and rising price movements of thousands of individual indices, shares, bonds, currencies, and interest rates from all over the globe.
The Risks of CFD Trading
Risks are always associated with profit. Alike with any other financial investment, opting to trade CFDs also comes with some risks. The associated risks are mentioned below:
Leverage
The risk factor of contract for difference trades is as high as a purchase of traditional face value stock, despite the lower margins. This implies that the CFD investments of a trader are more probable to fluctuate as compared to a standard share purchase. Due to this reason, CFD trades possess the risk of losing more than the initial investment of 5%. The quantum of such losses can exceed up to several times the investor’s initial investment.
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Volatility
Financial Markets can move swiftly and unpredictably, and the prices of instruments reflect such fluctuations. As CFDs are derivative assets based on the trader’s assumption of the market’s conditions, there is always a potent market risk. Small fluctuations in the industry can impart a major influence on the profitability of the trader’s investment.
Holding costs
You may include holding costs while trading with CFDs. It depends on the positions you hold, and the period for which you hold them. Specifically, when an investor trades in position for a long time, the sum of the holding costs incurred may exceed the amount of any profits earned, or they could substantially inflate the losses, as the case may be. In order to cover such holding costs, it is highly considered that you hold adequate funds in your account.
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Despite these risks, CFDs can be secured by executing limit orders or stop losses at unfavorable prices to avoid holding onto the agreement past its time of profitability. It is done to delimit the risks, and influence of the market volatility. CFD trading can be a highly gainful investment if the risks are comprehensively studied and examined.
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