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What are CFDs and Why do Investors Use Them?

A contract for difference (CFD) serves as a contract between brokers and buyers which allows buyers to bet on an asset’s fluctuations without actually buying shares directly from the asset. The difference between the value of the stock when the contract opened and its value when the contract closes is the investor’s profit.

Who uses CFDs?

CFDs are most attractive to experienced traders. There are a few reasons for this, but maybe the most likely is that CFDs do not result in the delivery of physical goods. Instead, they serve as a tool which allows traders to bet about how the price of a particular asset will fluctuate. Instead of purchasing a fluctuating asset such as gold, for example, traders using CFDs are betting on gold’s price fluctuation without investing directly in the metal.

If you know that you want to invest in an asset’s movement rather than purchasing it outright, CFDs might be a good pick. CFD investors do not own underlying assets, but rather benefit from the change and volatility of the asset over time. Let’s say a stock is worth $5/share at the open of a CFD and $10 when it closes. The additional $5 is the trader’s profit, less any fees such as the broker’s commission. Advantages of CFDs include ease of execution, access to underlying assets at lower prices than buying them outright, and the possibility of both long and short durations.

Note that CFDs might not be good picks for beginner investors, and you should do a bit more research on the best CFD brokers before you sign any contracts. The information available at ForexTraders can help you weigh the pros and cons of experienced and new brokers alike before you start trading.

CFD Advantages

In addition to the advantages already discussed above, CFDs have a few benefits over other trading options. Higher leverage, for example, is possible with CFDs and can range widely from 3% to 50%. The absence of borrowing stock and shorting rules is another reason these contracts have become increasingly popular over the years. Add to that the sheer variety of trading options, including everything from stocks to commodity, sector, and treasure CFDs, and it is easy to see why the trading option is so widespread.

CFD Disadvantages

Before you dive into the world of CFDs, it is important to note that there are both upsides and downsides to the contract. The investor’s initial position depreciates immediately, for example, which is impacted by the spread size when entering the contract. A potential lack of liquidity, weak regulation, and margin requirement are other reasons why you might want to steer clear of CFDs. Perhaps the most serious risk to weigh with CFDs is how quickly the market moves. If you are not prepared to closely monitor the asset in question, you might want to pick another trading option.

If you are interested in CFD trading, keep our tips in mind when placing your trades.

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