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Advantages Of Trading CFDs For Speculative Purposes
CFDs are popular derivatives that allow investors to speculate on the price changes of financial assets without necessarily owning them. CFD literally means ‘contract for difference’; and it is a contract between a broker and an investor to pay the difference between the opening and closing prices of an underlying asset. If your price prediction is right, the broker pays you the difference in the form of profits; and if your price prediction is wrong, you pay the broker the difference in the form of losses. The number of profits you can earn or losses you can incur when trading CFDs depends on the size of the trade position as well as the difference between the opening and closing prices of an underlying asset.
CFD trading has become a very popular method for speculating on different types of financial assets. Here is why:
CFDs are leveraged products. This means that you only need to put a small margin amount down so as to control a much larger trade position in the market. This is in contrast to traditional investing where 100% of capital is put into an investment position.
For instance, if you are buying a stock at $10 per share, you will only buy 100 shares with a capital of $1,000. However, with a CFD contract that has a leverage of 1:10, your effective trading capital is boosted 10 times ($10,000), which means that you will be able to buy 1000 shares! To understand what is leverage in trading, consider that the price of the underlying stock increased by 10%. In the traditional investment position, that will translate to a profit of $100 (10% of $1,000); whereas, in the CFD position, it will be a profit of $1,000 (10% of $10,000).
CFDs allow for maximum flexibility when trading financial assets. Since investors do not own the underlying asset (they only trade its price changes), they can go long or go short depending on market conditions, and with minimal or no restrictions. CFD contracts do not have an expiry date, no day trading requirements, and investors can implement strategies such as hedging. There is also the option of choosing flexible lot sizes of trade positions. You can buy full lot sizes or even small fractional lot size positions depending on your trading capital or investing strategies. When you are a beginner or trying out a new strategy, you can consider using smaller lot sizes before transitioning to much larger trade positions.
Through a single CFD brokerage account, investors can access numerous trading instruments in the global financial markets. There are CFD products for Forex, Stocks, Indices, Commodities, Cryptocurrencies, Bonds, and ETFs. All of these may be available on a single platform and investors can shift between different financial assets with just a few clicks.
CFD traders are charged a spread fee (the difference between the bid and ask prices) when they open a position in the market. Spreads are usually low and can be less than 0.1% of the overall trade position. Apart from spreads, there can be swap and rollover fees, but these can either be positive or negative depending on the tradeable instrument. Additionally, CFDs are known to be very tax efficient for investors, especially in jurisdictions that recognize tax profits derived from these products. Since they are technically not assets, they do not attract any Stamp Duty and may only be subjected to Capital Gains Tax.
CFDs are great financial derivatives, but they also carry great risks. Price volatility of financial assets as well as the inherent dangers of high leverage are the biggest dangers when trading CFDs. Leverage, as they say, is a double-edged sword. It can amplify your trading profits, but when prices go against your prediction, it can also magnify your losses.
This means that investors should learn to use leverage effectively so as to realize their investment objectives. It is generally recommended that beginners should use low leverage, whereas experienced investors can be more flexible with it. As well, investors should use low leverage when trading high volatility assets such as cryptocurrencies, while they can explore relatively high leverage when trading low volatility assets such as Bonds.
Financial assets are always vulnerable to market risk. Prices can turn volatile and lead to devastating capital losses, especially for highly leveraged CFD products. High volatility in the market can occur spontaneously or during events such as the release of high-impact data.
This can lead to price slippages or wider spreads that will increase your underlying trading costs. While it is wise to avoid trading during such times, investors may also be caught out unexpectedly. Nonetheless, the risk of price volatility can be limited by using orders such as take profit, stop losses, and conditional orders such as buy/sell limit orders as well as buy/sell stop orders.
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