If you aren’t too savvy with different kinds of trades, the idea of dealing with Contracts for Difference might seem foreign and a little bit overwhelming. Before you walk the other way, however, let us talk you through the “What,” the “Why”, and the “How” because trading CFDs is a lot more simple than they initially seem.
The basic definition of a contract for difference is a type of financial contract that allows the two parties to settle using the direction and movement without needing to own or hand off any securities or physical goods. It is a cash settlement that reflects the difference between the price of the instrument at the opening and the price at which it closes. When the underlying asset’s price goes up in relation to the price at the opening, a profit is realised.
There are many reasons why understanding the ins and outs of CFD trading can be extremely profitable. Here are just the top few:
Potential for Return – No Matter The Market
Because of the nature of CFDs, traders can profit whether the market is trending up or down if they know how to act and when. This is a huge benefit of trading CFDs because investors can trade on both sides of the market – long and short. If you have reason to believe that the price of a particular asset is trending upward, you can “go long” or take a long position and hold it in hopes that the market trends in your favour.
However, selling short may be highly advantageous, as the pricing of most CFDs changes quickly. Of course, there is a significant amount of risk for potential loss if market predictions do not perform as predicted. Still, there is also a great chance of capitalising on your investment and coming out on top.
Access to International Market
Unlike other major exchanges, CFDs are traded “over-the-counter” (OTC) on a platform that allows clients and brokers to form these contracts. Brokers organise the market demand and provide access to all kinds of securities, including currencies, stocks, indices and cryptocurrencies in financial markets worldwide. This allows investors to trade a wide range of global markets from one convenient platform that is open 24-hours a day.
Investors trade CFDs on margin, which means that they can borrow money to magnify their position to receive gains. This provides them with more leverage than typical share trading might. Standard leverage in this market is much lower than seen in conventional trading – dipping as low as 2 %. Numbers as low as these mean a potential for significantly increased gains because they have less capital outlay.
A little like the “Wild West” of early America, the market for CFDs has a much shorter list of regulations and rules than conventional trading spheres, and there is a wide-open field of opportunity. Lower requirements for capital, easy access to a wide range of markets, and zero short-selling rules make this realm an attractive one for many investors.
Since there is no need to own the underlying asset, there are no expiration dates or shorting costs for trading. However, because there are fewer regulations, it is highly important for the investor to vet their potential broker by looking closely at its track record, financial viability and overall reputation.
While it is obvious that trading CFDs can be highly profitable, there is also a chance for great losses without careful planning or coaching. Before jumping in with both feet, develop a replicable method, determine your entry and exit points, and do adequate research to know as much as you can about your target markets and how they seem to be trending.
Paramount to your long-term success is the broker that you choose to work with, so seek one out that provides you with a wide market, reasonable fees, and helpful information that enables you to succeed.