What is CFD Trading?
Contract For Difference (CFD) trading bears several similarities to spread betting, but unlike spread betting, CFD trading is not considered gambling so profits are subject to capital gains tax. But before we get stuck into the pros and cons of CFD trading, let’s start with the basics.
As the name suggests, a CFD is a difference between a trade’s entry and exit point. When trading on this difference, traders take the opportunity to turn a profit when the underlying asset moves in relation to the position taken on the market, despite never actually owning the underlying asset. Simply put, we’re talking about a tradable instrument that mirrors any movements of the underlying asset, upon which a contract can be drawn up between a client and a broker.
CFD trading offers excellent margins, especially when compared with 50% of traditional brokers. With a CFD broker, however, margins of as little as 5% are required, meaning a much smaller cash outlay. When entering into a CFD trade, bear in mind that the position will show a loss equal to the size of the spread. For the position to be at a breakeven price therefore, the stock first needs to appreciate the spread value. If you had opted to buy the stock outright instead, you would have gained the spread value but paid a commission for the privilege, and not to mention have a bigger capital outlay.
Because of the fact that CFD traders open and close trades based on value difference, they have the opportunity to turn a profit regardless of which way the market swings, but that’s not the only appeal. CFD trading grants users the ability to trade on a staggering range of markets, including (but by no means limited to) indices, shared, Forex and commodities. If you were to trade a share CFD, you’d benefit from all the same advantages of traditional share trading, but with the convenience of CFD trading.
Expiry in CFD trading
Another benefit of CFD trading over traditional trading firms is the lack of expiry date. In order to close out a given position, all you need to do is place a trade of identical in value in the opposite direction. Similarly, in other trading areas like options, there exists a depreciation value as the trade reaches its expiry date. This means that, even though you may have made a good trade, if you leave your closing time too close to the expiry date, you could still turn a loss. In CFD trading, however, no such depreciation occurs, because expiry doesn’t exist in the same way.
Risks of CFD trading
The main risk associated with CFD trading is that you are trading leveraged products, meaning the scope of your losses could be huge in the event of unfavourable market swings. This means that in times of loss, the lost value can increase exponentially, so you should exercise caution when trading CFDs. With that being said, the same rule applies vice versa, so your profits can come thick and fast if you follow successful trading strategies.
