cfd trading

For those who have not traded CFDs before, it can be a confusing and overwhelming experience. But, once you understand how they work, trading them becomes hassle-free and easier. Hence, to gain an in-depth understanding of CFD trading and its advantages & disadvantages, we have outlined a step-by-step breakdown.

Contract For Difference, or CFDs, are simply trading instruments where you predict the movement and direction of the underlying asset without actually owning it. This asset can be a commodity, currency, index, share or cryptocurrency. Typically, CFD is a contract between the two parties for the settlement of differences between the opening and closing price of the CFD instrument. The profit/loss is realized on the basis of the movement of the underlying asset with respect to the position taken by the trader.

CFDs are a leveraged product; thus, traders have more purchasing power at their disposal and can capitalize on their investment fully. However, just as the potential profits can be increased, so can the losses if the market takes a direction opposite to what you anticipated. That’s why a solid risk management plan is crucial for CFD trading.

Margins:

Margin is the amount a trader must deposit in their account to open or hold a CFD position. It is expressed as a percentage of the total value of the underlying position and depends upon how liquid and volatile the instrument is which is being traded. Margin requirements can vary from one trading instrument to another.

Leverage:

The basic idea of using leverage is to gain the maximum exposure to the price movements of CFD assets and open larger trading positions – which otherwise would not have been possible. With leverage, CFD traders can open their desired position even with a smaller deposit. The rest of the requirement is covered by the broker. However, it’s worth mentioning that leverage carries certain risks, and many traders have lost more than what they initially deposited because of their poor risk management strategy.

Higher Leverage

CFD trading is an excellent option for traders looking for higher leverage which is not possible in conventional trading, such as stock trading. Some CFD brokers offer leverage with margin requirements as low as 0.20%. Hence, the lower the margin requirements, the lesser capital you require and the greater the potential profits. But traders must not forget that leverage can magnify potential losses as well.

Greater Liquidity

CFD trading allows traders to take advantage of greater liquidity in the form of liquidity in the underlying market along with the liquidity offered by the CFD broker.

Wide Range of Trading Opportunities

CFD trading has many opportunities to offer to traders, including currencies, stocks, indices, commodities, etc. Thus, traders can access several financial platforms under one CFD platform.

Potential Losses Can Exceed The Initial Capital

Undoubtedly, leverage is a double-edged sword. On one side, it enables traders to increase their profits by capitalizing on a favoring market. But at the same time, it can lead to significant losses (that can even exceed your initial deposits), which means they may end up owing money to their broker.

Risk of Trade Closure

Traders must make sure that their trading accounts possess sufficient funds (required margin level) at all times. Failure to do so can force the broker to close your open positions.

Bottom Line:

CFD trading is advantageous as it provides access to a wide range of trading instruments under one platform. It allows traders to enter positions which otherwise would not have been possible by offering higher leverage. But note that trading CFDs is a risky endeavor; hence, you must only trade with the amount you can afford to lose. Choosing the right CFD broker with low fees and wider spreads is also important. Only then can you make the best returns from CFD trading.