What are CFDs?
CFDs are contracts for differences – in other words; they’re agreements to buy or sell an asset at a later date for a set price. The critical difference between CFDs and other types of investments is that you don’t own the underlying asset. It means that you can trade on the price movement of assets without going through the process of buying or selling them outright.
How does CFD trading work?
Say you want to trade on the price movement of shares in Company XYZ. You believe that the shares will go up in value, so you buy a CFD contract. If the shares do rise in value, you can then sell the CFD and pocket the difference between the price you bought it and the price it’s now worth. If the shares fall in value, you’ll make a loss.
It’s important to remember that with a CFD, you only ever trade on price movements – you never actually own the underlying asset. It is different from buying shares outright, where you become a shareholder in the company and have a claim on its assets.
How to get started in CFD trading
If you’re interested in getting started in CFD trading, the first step is to open an account with your chosen online broker that offers this service (visit this site).
You’ll need to deposit money into your account, which will be used to cover the margin for your trades. It’s important to only trade with money you can afford to lose. Once you’ve opened an account, you can start trading CFDs on many underlying assets.
Here are some of the key benefits:
You can trade on leverage.
A key advantage of CFD trading is that you can trade on leverage. You only need to put down a small deposit – or margin – to control a much more prominent position.
It allows you to magnify your profits (or losses) by increasing your exposure to the market.
You can go short as well as long.
With CFDs, you can trade in both directions to speculate on an asset rising in value (going long) or falling in value (going short).
It’s a highly flexible way to trade.
You can trade them on a wide range of underlying assets, including shares, indices, commodities, forex, etc.
You can also trade CFDs using various strategies, including going long or short, using leverage, setting stop losses, and taking profit orders.
You don’t have to pay stamp duty.
When you buy shares outright, you have to pay stamp duty – a tax levied by the government on the transfer of shares. However, you don’t have to pay this tax when you trade CFDs.
It’s a relatively straightforward way to get started in trading.
CFD trading is a relatively straightforward way to get started in trading. The process of opening and closing trades is similar to other types of trading, such as share trading.
It’s also easy to find information and education on CFD trading, as many online brokerages offer this service.
Here are some of the risks to be aware of:
Volatility risk
The prices of assets can be volatile, which means they can go up and down quickly and unexpectedly. It is particularly true in economic or political uncertainty when asset prices are more likely to fluctuate.
Leverage risk
CFD trading enables you to trade with leverage, which means you can control a more prominent position than the amount of money you have deposited. It magnifies both your potential profits and losses, so it’s essential to be aware of the risks involved.
Counterparty risk
When you trade CFDs, you enter into a contract with the broker or “counterparty”. It means that there is a risk that the counterparty will not be able to meet its obligations under the contract.
Market risk
The prices of assets can move up and down for many reasons, including political or economic events, natural disasters, and even rumours. There is always a risk that the asset you have invested in will lose value.