If you have read about contracts for difference on other websites, you may be wondering about whether they are a wise choice for long term trading positions. After all, as many people point out on the Internet, you are trading 'on margin', which means you are effectively borrowing most of the cost of the shares or other underlying security, and consequently paying interest. Even worse, the interest is charged every day to your account, which may mean you have to put more funds in even if the underlying has not lost value.
But just as you must know what you are doing to take part in any type of trading or you should expect to lose, this simply gives you another factor to add to the profit/loss equation when you calculate the risk/reward of the trade. The interest charged is perhaps a couple of percentage points over a standard bank rate, and if your stock pick is any good, you are probably expecting a better return than that. So long term trading with contracts for difference should not be ruled out on the basis of generalities, but considered carefully to see if it is the best way to make the trade.
 |
|
 |
|
Where CFDs really score is in the gearing or leverage that is available for your money. You can profit from maybe ten times as many shares as you could afford to buy because of the leverage that you get, so provided your choice is profitable, this can more than make up for the interest charged. The spread between the bid and ask prices is usually reasonable, and the commission for each transaction is not very expensive, being a fraction of a percent. Where it applies, you can save half-a-percent in stamp duty by not buying the actual shares.
But there are also other ways that don't involve paying interest that you can use contracts for difference in long term trading strategies. Going short can often be more profitable than buying or going long, as prices tend to fall faster than they rise. For example, if you foresee a decline, then you can easily take a short position using CFDs and actually get paid a minimal amount of interest for the duration of the trade. While the amount paid may not be very significant, that situation counters the argument of others that CFDs cannot be used long term because of the charges.
If you own shares and you expect that there will be a downtrend, you can keep your shareholding and take a short position in CFDs to avoid loss. If the shares go down, the CFDs will increase in value by the same amount, hedging your position. Hedging like this can also be done with options, but they are not as flexible, as you must take a set size of shares. Certainly if the shares instead increase in value, you neutralize the potential gains by losing on the CFDs, but that is not what you anticipate will happen. Taking the CFD position is protection from loss.
