For experienced investors, CFD trading offers plenty of opportunity to diversify their portfolio and profit from the movement of prices in the financial markets. But it also comes with its own risks, just like any investment, so should be researched and compared to the more traditional ways of investing in the market. There are many advantages and disadvantages when it comes to CFD trading, and here we take you through some of the most important ones to consider.
What is CFD Trading?
First of all, it’s worth understanding what CFD trading is. CFD stands for Contract for Difference, and allows for trading based upon the predicted value of a financial asset, without actually owning the asset itself. Investors can partake in CFD trading by speculating on the price movement of an asset and opening a financial contract with an online provider. The trading and exchange are based on the difference in price between the opening of the contract and when it closes, mirroring that of the underlying asset.
Long and short positions
The fact that CFDs work on the prediction of price movements, means that investors can use them to take a position on both rising and falling markets, and with a short position, they can profit when the underlying asset drops in value. Trading with a long or short position is made easy with CFD trading, and as it doesn’t require actual ownership, selling is easier than going through a traditional stockbroker.
If an investor expects the market to rise, they can take a long position, buying CFDs with the aim to profit from the upward movement in prices. But the advantage of CFD trading, is that investors can also take a position if they predict the prices of the asset to fall, going short with the aim to sell.
Worldwide market access
A benefit of CFD trading is the opportunities it allows for investors to easily diversify their portfolio, with the availability of various instruments, such as forex, metals, energy, stocks, indices, cryptocurrencies, and the option to start with a low initial deposit. Traders are also able to trade in international markets, usually all from one account.
Another advantage is that many providers of CFDs have extended hours compared to the traditional financial markets, so investors can continue trading after the underlying exchange has closed for the day. However, these extended hours could lead to a holding a position overnight, which in some cases can consist of a charge for doing so.
Trading with leverage
The main advantage of CFD trading, and one of the reasons it’s popular amongst investors, is that it allows them to have a much larger position on the market, investing a smaller amount of capital compared to the actual value of the trade. As well as market exposure, this can enhance the returns from the investment, and makes a more efficient use of the capital used.
However, just as it is one of the top benefits, leverage is also one of the disadvantages of CFD trading. When using leverage, there runs the risk of increasing your losses as well as your profits. This is because the outcome is calculated on the full size of the position, not on the actual amount invested, so could mean your losses are magnified as much as your profits. Therefore, it is always advised to research and take into account the leverage ratio when CFD trading, and new traders should try to start with as low leverage as they can. Knowing the risk element of leverage trading with CFDs, and understanding the right balance of leverage, is key to successful investment and can reduce the impact when the position taken goes in the wrong direction.
CFD trading is a popular strategy for many seasoned investors. But for any trader considering CFDs, it is always recommended to understand exactly how they work, and know the pros and cons of this type of trading, before investing.