Trading CFDs can be remarkably profitable, but this is not the easiest form of investing to understand. It is a flexible investment approach that offers tremendous scope as far as asset classes and markets you can trade. It is also a highly leveraged way to invest, which brings both higher risks and rewards. Here are some things that you need to know about CFD trading.
1. With CFDs, you never own the underlying asset.
A CFD is a “contract for difference”. You select some asset, such as a stock, that you want to invest in. When you do this with a CFD, you get the gain (or loss) from this stock changing in price, but you never really own any shares of the stock.
2. CFDs are lower cost than buying stocks.
If you buy a stock or other asset the traditional way, you pay the going share price and then own those shares. If the share price is $115, then you need to invest $11,500 to buy 100 shares. With CFDs, you can get the equivalent investment for a much lower cash outlay.
3. CFDs offer high leverage.
When you trade CFDs, you do so using leverage. Depending on your broker and what you are investing in, your margin requirement could be anywhere from 2% to 20%. If you had a 5% margin, then you could invest in those 100 shares of stock for just $575 instead of the $11,500 it would cost you to buy them normally.
4. Leverage increases both returns and risks.
This high leverage can give you a much greater return on your investment, since your returns will be multiplied. You only put in 5% of the cash on the investment, yet get the same return as if you had put in the full 100%. The downside is that high leverage can also multiply your risks, the same way it multiplies profits.
5. You pay interest on CFDs.
When you buy a CFD using margin, you are essentially borrowing the remainder of the price from your broker. This means that you pay interest on that money, which is usually calculated every night.
6. CFDs let you profit if something goes up or down.
Similar to how short selling can let you profit even when a stock goes down, CFD trading also lets you make a profit no matter which way the market moves. CFD trading is more flexible than short selling, however, and there are fewer restrictions on what you can do.
7. CFDs let you invest in many markets.
You can use CFDs to invest in many different things. You can use them for individual stocks, stock market indices, different stock markets around the world, commodities, bonds, precious metals, and even foreign currencies.
8. CFDs are often used for hedging.
Many sophisticated investors use CFDs as a way of hedging some of their positions. If they have a sizable position in something, they can offset that risk by putting a smaller amount into a CFD. This is an advanced technique that can be very effective.