Over the past decade, CFDs (Contracts for Difference) have become one of the most popular ways for investors to trade commodities, indices and currencies online. Although they have grown rapidly and many online brokers now offer them to traders, CFDs are risky and certainly not suitable for everyone. Understanding the volume of potential gains and losses is just one important consideration in deciding whether CFDs are right for you.
CFDs may look attractive because if you do not have the money to buy the underlying assets you can still take a share in the potential gains in the value of those assets using leverage, but the biggest risk with leverage is that it eventually makes you exposed to losing much more than you put in. Thus any large gains can be offset with large losses. Learn what it means to trade on leverage and margin before using CFDs.
What are CFDs?
CFDs can be traded on a variety of financial instruments such as stocks, indices, commodities or currencies. The profit in CFDs depends on the change in the value of the underlying asset over time. In both cases you can get the difference between the closing price and the opening price of the contract. It works as an agreement between two parties to exchange the difference in the price of the asset. This means that you do not have the asset in real terms.
Learn more about what are Contracts for Difference and how they work
How do CFDs work?
CFD trading is similar to investing in any other financial market. For example, if the price of a commodity rises by 10% then you have earned the same percentage. If the commodity falls by 10% then you will lose the same 10% value. The main difference between the actual investment in financial assets and investment in CFDs is that the contract gives you more flexibility and you can also apply leverage that maximizes profits. You can also use stop loss orders and choose when you will take your earnings, loss ratio and closing time of the transaction.
Do you profit only when prices rise?
One of the big advantages of CFDs compared to other financial instruments is that you can take advantage of price declines as well. Remember that CFDs are all about the difference in price, where you can invest in high or low prices according to what you think is more likely to happen.
Is CFD trading more risky than traditional investments?
Any financial investment involves risk and CFDs are not exempt from that rule. In fact, they can carry substantially more risk when using leverage, which increases your exposure to the markets. Leverage increases your profits but also increases your exposure to losses.
Why do traders prefer CFDs?
Apart from the ability to borrow and take advantage of leverage, there are several good reasons why many traders prefer CFDs:
- No fees are paid for trading contracts apart from the spread (see this brokers’s CFD pricing).
- You can access a large segment of markets including commodities, indices and others.
- You can access all the markets from a single trading platform.
- Trading is possible when the market is closed due to 24-hour trading.
If any of this appeals to you or you would like to learn more, get in touch with us below and we’ll take you through the entire process step by step. And remember, a risk-free demo account is a great way to try things out before committing any actual money.