CFD is short for Contract for Difference and is a derivative form of trading. The main attractive feature about it for traders is that it allows them to wager on the constant change of prices for assets like shares, commodities, indices, foreign exchange and treasuries in a way that is very cost efficient.
If a trader is confident that the price of an asset will go down they can buy it. In trading terms, that is to ‘go long.’ If they feel the price will go up can ‘go short’ which means to sell. Part of the cost efficiency in CFD trading is that it allows you to trade on margin, as in you do not have to expose the full capacity of your financial position in the market. And since you do not necessarily have to own the assets you are trading, you are not required to pay for stamp duty.
How does CFD Trading work?
As mentioned earlier you do not have to own the underlying asset to trade. Depending on the direction you think the prices will take off in, you simply need to buy or sell a certain number of units of a certain asset. These assets or instruments can be shares, indices, currencies etc.
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The fluctuation of prices is determined in points. For every point the price moves in your desired direction, your profit will multiply according to a number of units you have either bought or sold. For every point the price moves against you, your loss will be calculated in the same fashion. It is important to note that a potential loss can go past your initial deposit.
1) Leverage and margin
Since in a CFD trade you only have to deposit a minute percentage of the entire value of an instrument in order to trade, it is considered to be a leveraged product. The fact that you do not have to purchase the entire instrument and open a position with a minor percentage means that you are trading on margin. The upside is that you can make a significantly high profit out of a relatively low deposit. The downside is this same principle applies when it comes to losses. In fact, you stand to lose more than your initial investment.
2) Costs involved in CFD trading
- Spread: The spread refers to the difference between the buying price and selling price of a trade. You will enter into a trade with the buying price and exit using the selling price. The smaller the spread between the two, the lesser the price must move before you stand to make a profit… or a loss.
- Market data fees: A trader is required to open a subscription to access details of prices on the market. A fee is charged for each subscription.
- Holding costs: If there are positions open on your account by the end of trading time for the day, you may be liable for a charge known as a holding cost. It could either be a positive or negative going by the holding rate applicable and your position’s direction.
- Commission: This applies for shares only. A minute percentage of the marginal value only is charged as a commission for each CFD trade. For trades based in the UK for instance, commission charges begin at 0.1%.
As a novice trader, it is good to begin with a demo account until you are more familiar with the system. CFD trading is a great way to make substantial revenue out of tiny investments. However, it does come with its own unique set of risks but that is all part of playing the game.
How to Choose the Right CFD Broker
When it comes to CFD trading choosing the right broker is crucial.
There are several factors to consider when selecting a CFD broker including regulations fees trading platform and customer support.
To ensure the safety of your funds it is important to choose a regulated broker.
Look for brokers that are licensed by reputable financial authorities such as the Financial Conduct Authority (FCA) in the UK or the Australian Securities and Investments Commission (ASIC).
In addition to regulations consider the fees charged by the broker.
This includes spreads commissions and any additional charges such as inactivity fees.
Compare the fees of different brokers to find one that offers competitive rates.
Another important factor is the trading platform.
Look for a platform that is user-friendly reliable and offers advanced features such as real-time market data charting tools and technical indicators.
A good trading platform can greatly enhance your trading experience.
Lastly consider the customer support provided by the broker.
Look for a broker that offers responsive customer support through multiple channels such as phone email and live chat.
This will ensure that you can get timely assistance whenever you have a question or encounter an issue.
In conclusion choosing the right CFD broker is essential for successful trading.
Consider factors such as regulations fees trading platform and customer support to find a broker that best suits your needs.
By doing thorough research and comparing different brokers you can make an informed decision and enjoy a seamless trading experience.