What is Contract for Difference (CFD) Trading?
What are CFDs?
A contract for difference (CFD) is a contract between a buyer and a seller that stipulates that the buyer must pay the seller the difference between the current value of an asset and its value at contract time. CFDs offers traders and investors the opportunity to profit from price movements without owning the underlying asset. The value of a CFD contract does not take into account the underlying value of the asset but only the price change between the opening and closing of the trade.
The CFD Markets
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Benefits of Contract for Difference (CFD) Trading
CFDs provide higher leverage. This means that traders can gain greater exposure to CFD movements for a relatively small cost in trading spreads alone. Although that leverage can amplify gains it can also amplify losses, so a right risk management strategy should be followed when trading CFDs on margins. In addition, CFD also offers the opportunity to trade in bull and bear markets.
Disadvantage of CFDs
Traders pay the spread. By having to pay the spread on entries and exists eliminates the potential to profit from small moves. Spreads also slightly decrease trading profits and slightly increase lose compared to the underlying security. Although, the traditional markets expose the traders to fees, regulations, commissions and higher capital requirements CFDs trim traders’ profits through spread costs.
Another disadvantage is the risk. CFD trading is fast moving and requires close attention so, traders should be aware of the risks when trading CFDs. Additionally, there are liquidity risks and margins you need to maintain, if you cannot cover reductions in values, then your provider might close your position and you will have to meet the loss.
It is possible to make money trading CFDs. However trading CFDs is a risky strategy compared to other forms of trading. Although that CFD trading includes lower margin requirements. in the event of highly leverage losses you may have to pay a spread to take an exit position if there is no significant price movement which can be costly.