CFD trading works in a simple way. A trader and broker enter into an agreement. Let’s say the CFD trader believes that the financial market’s value will rise. The trader opens a position to purchase CFDs in this market. If the price of the asset rises, the trader makes a profit. If the trader expects that the asset value will drop, they either sell CFDs or ‘go long’.
If the trader is wrongly predicting market movements, they must bear the losses. Profit or loss is the difference in the asset’s price at the beginning and the price at its end.
CFD trading Pros
Contract for Difference is a leveraged financial instrument that requires only a small percentage of the trade value. This is called the initial margin. This increases the risk of the deposited funds and allows traders to make bigger trades and potentially earn more.
Contract for Difference is more flexible than traditional shares, commodities, and so on. CFDs can make a falling market a great trading opportunity.
You’ll see two buttons when you open a trade platform. These are ‘Buy’ or ‘Sell’. This button allows you to go short on a market. In other words, you borrow the item, then sell it and then purchase it back to close your trade.
Short selling is motivated by the prediction that an asset will fall in price, which allows you to purchase it back at a lower profit.
No stamp duty
CFDs track the underlying market. CFDs that you purchase on Netflix shares are not investments in the company or shares. You speculate on price fluctuations.
You will be subject to a stamp duty at 0.5% if you hold assets if you engage in traditional share trading within the United Kingdom. CFDs offer a clear advantage in this regard. CFDs are not held in the underlying market so you don’t need to pay stamp duty.
CFD trading Cons
Ironically, CFD trading’s main advantage – leverage – is also its biggest drawback. Leverage allows for a smaller initial deposit to gain greater exposure. You can significantly increase both your potential profits as well as your losses by leveraging your investment position.
Your CFD broker will issue a margin call if the market is against you and your margin falls below the agreed level. They will ask you to either deposit more funds, or close your positions completely or partially. Because the asset value can increase infinitely, short sellers could suffer potentially unlimited losses.
To reduce your trading risk, it is important to use smart money management and stop loss.
This is the interest you pay to hold a leveraged position for an overnight period. The CFD value is used to calculate the fee. It is deducted daily for each day you keep your position open. The fee will not be charged if the position is closed before the overnight fee, which is usually at 10 p.m. UTC.
Different underlying markets have different charges. This short video explains how Capital.com receives its overnight fee for shares and commodities, as well as indices and currency pairs.
Ownership is not required
CFDs can be used to speculate on price movements, but not for purchasing the underlying assets. You own the contract and not the commodity, currency, or share on which it is based.
This can be advantageous in the case of commodities as you won’t need to locate a storage place for the asset. However, CFDs are less reliable than traditional share trading. Having shares in a company gives your voting rights and the potential for dividends.
Contracts for Difference are financial instruments that have both inherent advantages and disadvantages. Before you start CFD trading, be sure to carefully consider them.