CFD trading is defined as ‘the buying and selling of CFDs’, with ‘CFD’ meaning ‘contract for difference’. CFDs are a derivative product because they enable a trader to speculate on financial markets such as shares, forex, indices, and commodities without having to take ownership of the underlying assets. In CFD, the trader doesn’t have to buy the security. Instead, he/she buys the right to speculate the changes in the market price of the security thus assessing greater exposure to financial markets. CFD is offered by many different institutions. It involves very high profits but at the cost of high risks as well. It is a contract between a broker and a trader when both of them agree to exchange the difference in the value of underlying security between the beginning and the end of the contract.
What are the advantages of CFD trading?
- Higher Leverage
The main benefit of using CFD Trading is that it provides higher leverage than traditional trading. It can range between 2:1 leverage to 50:1. It implies that less capital is required to start investing by the trader/investor. In return, it offers greater potential returns.
- Trade on both rising and falling market
CFD Trading can be opened on either short or long positions depending upon the market conditions and the trading strategy of the trader.
- Global market access from one platform
Many financial institutions offer platforms throughout the world’s major markets. Along with that, they allow around the clock access.
- No exchange fees
An Exchange fee is collected on an asset but the trader in CFD trading doesn’t own the underlying asset. Therefore, he/she does not acquire any rights or obligations in relation to the underlying asset. It is just a contract between the client and broker/institution.
- Fewer barriers to entry
Unlike traditional trading, a trader can enter the CFD market by simply registering with any financial institution and making a deposit. CFDs don’t put many financial restrictions.
- Quick and Accessible trading
CFD trading allows investors and traders to access the market directly, even without a broker. Therefore, this is a quicker medium for trading. Also, it is easily accessible by novice traders who are just learning about the forex market or any other financial market.
- No day trading requirement
The CFD market is not bound by any restrictions such as a restricted number of transactions and all account holders can day trade if they wish. Also, there is no minimum deposit requirement.
What are the disadvantages of CFD trading?
- Less Credibility
Since the CFD Trading industry isn’t highly regulated, therefore there are lesser restrictions and easier entry. This makes CFD trading less credible.
- High dependence on a broker
In the case of the involvement of a broker, there is a high dependence on the broker. The broker’s credibility is based on reputation, longevity, and financial position in the market. However, trusting someone with your money is a difficult decision to make.
- High Risk
High leverage comes with the cost of high risk. And the margin traders can not only magnify profits but losses as well.
CFD trading can be very beneficial if used judiciously. Else, it might incur irreparable losses that are difficult to overcome. Each trader/investor gets to learn each day while he is involved in the financial market. Use leverage and bear that much risk only when you have researched well.
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