Why Trade CFDs: Advantages of CFD Trading
Put simply a CFD or Contract for Difference is a cutting edge global trading product that people choose to trade instead of shares. CFDs have only been in around for a few decades but they are growing in popularity.
Whether you choose to trade CFDs is up to you however we recommend that you seek education before you open an account and start trading CFDs. A CFD is not a share, but it is like one in many ways and traders choose them for many great reasons.
Contract For Difference, or CFDs, are a trading product where you to trade movements in the stock prices, without having to physically own the underlying shares in the case of non DMA CFDs.
A reason why they differ from ordinary shares as a trading product, is that they can be traded with leverage, which in effect magnifies your trading results. Remember of course that leverage magnifies your trading results so if you have wins or losses, they are both magnified. Hence leverage must be used wisely.
Also, they present many more shorting opportunities than is possible with share trading, so you can profit in falling as well as rising markets.
CFDs are appealing to traders due to their simplicity, lower trading costs and flexibility. Traders can purchase contracts speculating on shares, commodities or other financial items with a few clicks on their computers. CFD trading costs are usually lower than other financial tools. The trading fees, commissions or overnight charges, and spreads tend to be lower than trading the underlying assets directly. Unlike other financial instruments, CFDs offer traders an almost unprecedented choice of markets and a global reach.
In summary, the advantages of trading CFDs include:
Trading with as little as 1% of the value of what is being traded – CFDs allow you to use leverage which means you can magnify your profits in some cases up to 100 times. You can also magnify your losses*. That means $1,000 can get you $100,000 exposure to the market!
This, as mentioned, magnifies your trading results. So if you have a profitable system that returns 30% without leverage, and has a 15% drawdown, then with leverage, the system would be expected to return a multiple of this number. As you can see, with leverage the profitability can increase, but your losses can be larger than your cash float because of the leverage.
Of course, you do not have to use the total leverage offered by the market maker. Remember that leverage is a magnifier of results, so the more leverage is used, the greater the risk and higher the chances of margin calls also.
Some providers provide CFD platforms with no available leverage and a commission rate that is difference to their CFDs with leverage.
Ability to go Short on more Stocks
Profit from rising and falling markets – You can profit from CFDs in all market conditions both long (rising or bull markets) and short (falling or bear markets).
The ability to go short with ease gives you more trading opportunities, and hence, assuming a profitable system, will allow you to profit in falling markets. With any particular CFD broker, not every CFD will necessarily be able to be shorted. Check with each broker that you’re considering their list of current shortable CFDs, if they this is available.
The specific CFDs on these lists may also change from time to time.
Huge Range of Markets
CFDs allow you to trade UK, Australian, European and global shares, index, sector, treasury and commodity CFDs. If you have a view on a market sector (mining, energy or banking), Oil, Wheat, US TBonds or an entire index (US30, UK100, ASX200).
Ability to place Stop Loss Orders
With most market makers, you’ll be able to place stop loss order that are automatically filled. This means that you’ll be able to do intraday exits, and have them performed automatically, rather than having to exit the next day if your stop is breached, or having the possibility of using emotion and discretion (for those trading mechanical systems) getting in the way.
It also means it is easier being in many positions at once, as this leg of the trade is automated. Though this is the case, you should always check to see that the trades you’re supposed to be exited from, is actually exited.
Lower Transaction Costs
CFDs allow you to gain exposure to a share price without actually buying the share. The full explanation is that a CFD is a contract between two parties (possibly, you and your CFD provider) to exchange the difference between the purchase price and the sale price of a share. When you buy a CFD you own a contract over the movement in the share price that is re-valued in real time.
For example, if you buy a CFD at $1.00 and the price rises to $1.10, then your contract is for the difference between the purchase price and the current price, which is a 10 cent profit. If the CFD had decreased in value, then you are obligated to pay the difference.
In the case of many CFD providers, the commission costs are relatively low compared to shares. However remember that there are differences apart from commissions. With CFDs there is a financing cost of long positions with CFDs. So you need to workout for an average trade with an average trade length, that the lower commissions outweigh the financing costs. With most CFD brokers, when you are long a position, and the underlying share goes ex-dividend, then you will be credited the dividend. If you are short the position, then you will be debited the dividend.
Read more about the costs of CFD trading.
Ability to place orders out of hours (for some providers)
With some CFD providers, you can place your orders in the evenings when the market is closed, such as orders to enter a new position, or to adjust a stop loss. This is convenient for those who are working or are otherwise busy during the day, and can’t get to the computer screen during market hours.
The order types available do vary between providers so check with each one their various rules and order types to see if they can perform the types of orders you require. This means that you must be clear as to the requirements of your trading system.
* A leveraged investment in derivatives carries a higher degree of risk to the investor, and due to fluctuations in value, you may not get back the amount you invested. With certain transactions you may not only lose what you invested at the outset but may incur a higher liability depending on the amount of leverage you have taken.
Things to Remember About CFDs
While trading CFDs is not difficult, there are some aspects of contracts for difference that you should understand. This section will cover some important points that you should remember about CFDs.
When trading CFDs, be aware of the trading costs. While share CFDs are very similar to trading the shares themselves, other types of CFDs involve slightly different cost considerations. Those types of CFDs involve overnight rollover charges and a spread, which is a small fee that brokers charge for the trade.
Some of the appeals of CFD trading are its simplicity and cost savings. Unlike trading the underlying assets themselves on an exchange where investors are restricted to buying in certain increments or minimum amounts, CFDs are more accommodating. The minimum trade size for CFDs is usually 1. This means that you can create a contract for difference for 1 share of Apple or 1 share in S&P 500. However, commodity CFDs are slightly different and contract minimums can vary. Regardless, the minimum size of those commodities when trading CFDs is smaller than they would be if trading those commodities on an exchange.
Margin and leverage are important concepts to keep in mind when trading CFDs. Margin is the percentage amount a trader needs to deposit into his trading account to control a larger amount of money. Smaller margins mean the trader has more leverage. When trading stocks, a $100 account can purchase $100 worth of shares. However, a $100 CFD account with 10:1 leverage can allow a trader to control up to $1,000 worth of assets. While this can greatly increase profits, it can also lead to greater losses.