Introduction to CFD Trading
CFDs, also known as Contracts for Difference, are derivative instruments in which a buyer and a seller agree to exchange the difference between an asset’s opening and closing price within a given time period. They are derivatives inasmuch as they allow live trading without the need of actually purchasing the asset in question, it is just the difference in value which is of interest to traders in a CFD contract.
CFDs are generally employed by traders in order to speculate on the future value of securities irrespective of whether the change is an upward or downward movement. The advantage CFDs have over other non-derivative instruments is that traders have the ability to go short (sell or in binary options terminology PUT) which enables them to profit in bear markets, as well as going long (buy or CALL in the parlance of binary options.) The shorting feature of CFD contracts is particularly attractive to investors as it allows them to hedge the exposure they have to certain markets in their physical investments.
CFDs are currently available on over 100,000 markets including a wide range of currencies, commodities, stocks and indices. The fact that CFDs are also leveraged products, means that smaller traders can enter otherwise prohibitively expensive markets at just a fraction of the overall value of the contract. This is a significant advantage for experienced traders without the necessary investment capital but can be dangerous for newcomers to trading, the reason being that a leveraged position that doesn’t go your way can result in losses that far exceed not only the value of the contract, but also of your deposit account balance. As such they should be traded with much more care than unleveraged financial instruments.
CFD Trading Advantages.
Longing and Shorting Positions
As already mentioned, much like binary options trading, CFD trading gives you the option to trade both bull and bear markets. Long positions are taken if the security in question is expected to rise in the near future; Short positions are taken if the opposite is true. Again we must reiterate the danger of trading with leverage, and invite you to peruse our family of articles on leverage and the tweaks in risk management it requires.
Hedging with CFDs
Say you have money invested in gold, and gold begins to drop in value, if you are reluctant to actually rid yourself of your store of physical gold, perhaps because you see the fall as a temporary blip, you can hedge your long-term position on physical gold by shorting gold with a CFD agreement. If you go short on gold, to the tune of the amount you already have invested in the precious metal (without indeed having to fork out the value of your gold investment if you opt to leverage the trade), you can then offset the losses you incur if the price of gold continues to drop whilst still holding on to your physical store of the commodity.
CFDs are also used by individuals wishing to reduce their tax outlays. For instance, many investors use the losses they may have incurred trading CFDs in order to offset the degree to which they are liable for capital gains taxes. This is a very attractive feature for many traders as it means that even losses made while trading can come with some financial benefit
One of the big advantages of CFD trading is that most brokers will allow you to access your account and trade 24 hours a day seven days a week. Some even permit CFD index trading even at times when the underlying markets are closed for business.
High Leverage Amounts
This can be both a positive and a negative depending on how you choose to look at it. Like it or not, CFDs are traded using leverage. This means that you only have to pay a small percentage of the total value of the trade you are entering into. Depending on who you trade with and what asset you are trading (currencies, stocks, commodities, indices) you only need to pay between 1- 5% of the complete value of the contract in order to enter a given market. As mentioned earlier, while this can be a good thing if a given trade goes your way, it can be very bad if it doesn’t, leaving your deposit account balance exposed.
No Stamp Duty
Due to CFDs being derivative instruments, meaning you do not actually purchase the undelying asset you are trading on, you are exempt from all stamp duties on the CFD trades you make. This gives CFD traders a 0.5% advantage over traders who take physical possession of the securities they trade on.
High Liquidity, Wide Range of Assets to choose From.
Most CFD brokers provide their clients with the opportunity to place trades on thousands of securities across all four main asset classes. If you thought the range of assets available from binary options brokers was impressive (and they are in comparison to Forex), you’ll be truly astounded as to what you can trade using CFDs. As soon as some new development takes place in the world’s markets then you can expect CFD brokers to already be offering their clients the ability to purchse contracts. A very good recent example of this is bitcoin, the virtual currency that has been garnering a great deal of attention of late, as soon as the public began to show more interest in it IG Markets, a leading CFD brokerage quickly began offering contracts on the future value of bitcoin.
Recommended CFD Brokers.
If you are interested in becoming a CFD trader we advise you to have a look at our comprehensive breakdown of each individual CFD firm in our CFD broker reviews. Here we provide you with a few of the most reputable companies in this industry in order to kick off your research.
- IG Markets
- Plus 500
- UFX Markets