CFDs stand for contract for differences. A CFD trader does not own the financial asset rather gets his profits or losses by speculating on an instrument. A CFD broker provides a medium for an investor to carry out their transaction, and in the meanwhile, the company makes money by charging a fixed commission or through spreads.
Advantages of Trading CFDs
There are tons of CFD brokers in the market, and the number is ever-growing due to its popularity. Let us discuss a few important benefits of trading CFDs.
- Leverage. Traders can use a significant amount of margin when trading CFDs. This allows investors with a small capital to make money in the markets as well. It can also add to the risk on the negative side.
- Instruments. CFD brokers can place all the financial instruments they can get their hands on under a single trading software. This can save traders from hunting out on different brokerages for trading a specific asset.
- Direction. Traders can speculate the market both on the long and short sides. They are not limited in terms of trading in one direction only.
- Orders. A variety of trading orders are available for traders. This can include Good Till Cancelled, limit, and stop executions. Investors can also hedge out of their positions use grid and martingale trading.
- Liquidity. CFD brokers connect themselves with deep liquidity providers, ensuring that traders are filled in on their positions efficiently.
- Regulation. A good amount of regulation in this financial class ensures that no trader is double-crossed while trading.
- Availability. CFD trading is available in almost all major countries. Traders have access to a wide variety of brokers in this class. This can help diversify the risk on different brokerages.
How can you start trading with a CFD broker?
Trading with a CFD broker is simple. Traders can sign up within a few minutes and start speculating the markets. Due to a good amount of regulation, CFD brokers may demand from clients to verify their credentials. A multiple-choice of deposit and withdrawal options are at the discretion of a trader.
Working Methodology of CFDs
When a trader trades using CFDs, they enter a contract with the broker, which allows them to speculate on the price of an asset without owning it. The buyer will pay the difference in the value of the instrument when the stated contract expires.
Costs of Trading CFDs
The trading costs of CFDs depend on the account and the broker. Traders can choose between two models, the details of which are as follows:
- Standard. When a trader selects these accounts, they are charged the trading fee through the spreads. The spread is the difference between the bid and the asking price. To understand this concept, let us consider an example when an investor shorts GBPUSD at 1.34120. With a two pip spread, they will have to wait until the asset goes below 1.34100 to get into profit.
- ECN. Electronic Communication Network offers faster trading speeds and charges a fixed commission on each trade. Traders may not have to cover any spreads in these conditions.
Other than this, traders may be charged roll-over fees when they hold positions over the night. This is not applicable for Islamic accounts as this goes against sharia.
While CFD trading may offer many benefits, traders should also consider the risks associated. A high amount of leverage on an account can wipe out the equity within minutes. Trading responsibly is the only way to ensure that an investor will survive in the markets for the long term.