CFD or contract-for-difference is a new and flexible type of trading. Owing to the plethora of sites popping up that let newcomers trade from the comfort of their homes, many new types of trading are also getting worldwide acclaim. This kind of trading is cost-efficient, easy, and flexible and is a growing trend from the past few years. New surveys prove that CFD trading is only bound to rise in the coming years.
Definition of CFD trading
It’s better to understand the concept behind CFDs to trade this type. CFD is an acronym for contract-for-difference. CFD is a settlement between a client and a seller. In this contract, the buyer has to fund a sum equivalent to the difference between the two prices. The difference is calculated by the cost price when the agreement was made and the sale price of any financial instrument. Financial instruments include assets like currencies, commodities, and the like.
In this contract, you do not have any underlying assets in real-time, making the trade cheaper than its counterparts. In addition, the buyer can profit from the exchange by just speculating the rise or decline in the price of an asset. As a result, CFD trading South Africa, New Zealand, Australia, Hong Kong has witnessed a tremendous boost in popularity.
How to do it?
CFD trading is slightly different from other trading types. But once a trader gets a hold on how it’s done, it’s not as complex as it looks. Following is a quick guide on how to trade CFDs.
- To start trading CFDs, you need to select a market to trade in; this market should be one that you are well-versed about. If you are unsure which market to trade in, you should benefit from the educational resources set up for you by different trading platforms and learn about markets.
- After you have selected a market to trade in, you need to choose whether you want to buy or sell. As a general rule of thumb, if you speculate that the price of the asset is going to decrease, you should sell. On the other hand, if you suspect that the price will shoot up, you should select the buy option for that asset. Although, You don’t own the purchase at that time, which makes this trade way cheaper than the rest.
- Next comes the part where you have to decide the size of the trade. This is the amount you can trade. It can be as much as or as little as you want. With CFD trading, you can even speculate about the price of a fraction of an asset and hence can trade with way fewer funds than traditional trading. Once you are sure about the size and the dimension of your trade, you can move on to the next step.
- Now, you have to place stops or limits on your trade. These are your closing points. These can be effective in night trading and automatically close your position before you lose more money than you deposited or when you have reached the considerable profit of that trade.
Pros and Cons of CFD Trading
Now since traders would have understood the basic pattern of CFD trading, let’s move on to the advantages and drawbacks of CFD trading.
Advantages of CFD trading
There are a plethora of benefits of CFD trading. One of the most prominent things about CFD trading is the ability to open both positions, long and short. For example, if you feel that a stock is overpriced, you can open a quick position and as the price declines, you can make a pretty good profit.
Another fantastic benefit of CFD trading is the instantaneous order execution. Suppose you open a position and see the change you’re looking for within a second; you can quickly close your work within seconds. Since the price difference is seen on a paper-thin margin, traders have to act swiftly and make decisions on their feet, and CFD trading offers them that.
The commission and charges of CFD trading are also relatively low. A general comparison between conventional trading and this type has shown a considerable difference between the commission and fees of both. Furthermore, CFDs are traded using leverage. It means that traders can have enormous profits with the least amount of investments.
Drawbacks of CFD trading
Just like anything else, CFD trading has some drawbacks too. Since CFD trading is leveraged, the profit can amplify, but the loss can too. It’s a double-edged sword and can potentially harm traders big time and make them lose more than the money they invested.
Due to it being super swift, traders often fall into a dilemma called overtrading. A trader should not run trades with emotions. If they open or close a trade too quickly, they can set themselves up for a short trading career.
Another downside to CFD trading is that even though it offers automatic closing positions called stops and limits, these can cost you a bit. The initial fee may not be as high, but overnight trading fares can eat the negligible profits you make.