A CFD, or contract for difference, is an agreement within two parties to agree, when the contract closes, the difference in between the open and close amounts of the contract, then multiplied by the amount of underlying shares that are stated within the contract.
The Advantages Of CFD’s
A CFD is traded on margin; therefore you are able to maximize your capital of trade. You will be able to profit from the rising and falling markets, depending on trading short or long. A single account will be able to provide you with accessibility to a large selection of financial markets. You also have the ability to manage and limit your risk by using limit orders and stop losses.
The Risks Of CFD’s
The nature of the markets for margin trading means that both the losses and the profits are able to be magnified, and if you don’t place a stop loss you may be losing a lot if the position goes against you. When you are an investor, you have absolutely no rights. This includes voting rights.
Main Features Of CFD’s
- Traded on Margin
Instead of paying the entire amount on a transaction, you will pay a percentage when you open the position. This is known as the initial margin. This will allow for leverage, and you can access more shares than if you were selling and buying them.
- Trade in Falling or Rising Markets
A CFD gives you the ability to trade short or long. The long trade consists of you buying an asset expecting it to rise with time, while short trading is where you sell the asset that you don’t possess hoping that the price will fall and you can purchase it cheaper in the future.
- No Stamp Duty
With a CFD, since you don’t actually own any of the underlying shares, you will not have to pay the stamp duty.
- Commission
Just like all share trades, commission is charged to a CFD. This commission is calculated based on the total value of the position, not on the amount of margin that is paid.
- Overnight Financing
Since a CFD is traded on margin, if the position is being held overnight it is subject to finance charges. Long positions are charged interest for overnight financing, while the short positions are paid interest.
- Trade Indices and Shares
A CFD will allow you to take a view on indices and shares, while some providers will allow you trading on sectors and currencies.
- Risk Management Facilities
Due to the risks that are involved with CFD trading, some providers will allow limit order and stop loss facilities.
Trading Strategies For CFD
- Short Term Trading
Being able to trade on a margin along with no stamp duty to make a CFD the perfect tool for short term trading
- Hedging
You have the ability to use your CFD to protect all of your holdings against the conditions of the market.
- Pairs Trading
If you think that one business has a lesser value than another, you may use a CFD to go long for the cheaper business and short for the more expensive business.
Megan Fletch is an expert in CFD trading and the market conditions. She uses this comprehensive guide to trading CFDs in order to maximize her potential and make the best choices in the type of market she trades in.