Positives and Negatives of CFDs

 Go back to Contracts for Difference and CFDs

Pros and Cons of CFDs

CFDs, like spread betting, allow you to go long, or to go short. These are terms that reflect on the price of the shares with which you are trading, if you go long, that means that you are trading on the fact that the value of the stock will rise, whilst going short, conversely is trading on the prediction that the value of the stock will drop. Going short, however, when it comes to CFDs is short-selling, and therefore currently banned on a wide variety of stocks.

One of the advantages of CFDs is that there is a wide variety of shares and indexes that you can trade upon, it is important, though, that you know the market you are trading in very well before you begin. It is possible to lose large sums of money on CFDs, and the companies that operate CFD trading, like City Index, are keen to make sure that those who trade on them know what they are doing.

The major advantage of CFDs is that the commission is low, the same process on the stock exchange would require a lot more capital, and would also be subject to UK Stamp Duty that would minimise your profits. Capital Gains Tax is also not an issue as CFDs count as gambling and therefore are subject to gambling tax.

CFDs are good because you can hold them for short periods, so in turbulent markets like the current ones you can buy or sell very quickly in order to try and turn a profit. There is no need to hold them and hope that your investment will mature. The flip-side of this, of course, is that they are bad value for long-term investors.

One thing to bear in mind is that whilst you might receive dividend payments where applicable, you also will have to pay them to the broker if you choose to go short, however, as going short is currently outlawed on large proportions of the stock exchange, it is not something to be concerned with.

Most brokers allow you to place stop-losses (the spread betting and CFD trading company CMC Markets offer a fixed risk account for instance), this means that you will not lose all of your money if it so happens that your judgement is wrong and the share value moves in the other direction. However, not all brokers do, and even if they do it might be set at such a level as to seriously damage you financially, make sure that you check where the stop loss level is, and keep it in mind.

CFDs are a dangerous commodity and not for the inexperienced, buying in CFDs means that the FSA (Financial Services Authority) will believe that you are a professional and, as such, you will lose some of the protection that you may otherwise have received. Be careful when engaging in the trade of CFDs and make sure that you know the markets that you are playing with.