Contracts for differences (CFDs) are contracts between an investor and a broker. The contract agrees that both parties exchange the difference between the asset value at the opening of the contract and the closing point. The trader can opt to go long or short, depending on the direction they think the market will take.
CFDs are always settled in cash because traders don’t speculate on underlying assets they own. This means that essentially, CFD trades do not involve physical goods, products, or securities as a means of payment.
What Financial Instruments Can Be Traded Using CFDs?
In CFDs, investors can benefit from price movements without owning a single asset. This is because CFDs are derivatives. Investors are therefore beneficiaries of the value of underlying assets.
Many financial instruments can be used to trade CFDs including; shares, cryptocurrencies, equities, indices, commodities, and many more. Most investors focus mostly on shares and the majority invest by using buying and holding strategies.
Understanding Leverage In Contracts For Difference
The unique point of CFDs is that they use leverage. In essence, leverage is the ability to gain market exposure without paying the full price value of an underlying asset. Traders only invest in a small deposit (premium) for the rights to trade CFDs.
This essentially means that investors can benefit from assets they do not own such that their returns are higher than their investment.
Premiums must be paid upfront i.e. before beginning to trade. This initial payment is only a fraction of the total price value of the underlying asset. But trading CFDs allows traders to benefit from leverage.
Leverages can also be risky. They can amplify losses just as easily as they amplify profits.
Costs Of Contracts For Differences
Trading CFDs, like other forms of trading, is not free. There are fees involved. We look into some of the words traders should understand and look into.
- Holding Fees
To keep a position open, there is a charge called a holding fee. This will be charged differently depending on the broker, the holding rates, and the direction of price movements. Usually holding fees are charged daily i.e. at the end of a trading day.
This refers to the difference between the buying points and selling points. The difference is non-negotiable and therefore it has to be paid.
- Market Data Fees
This is the fee charged to any investor seeking to trade within the CFD market or even view the relevant data.
This is also a non-negotiable payment made when trading with shares.
Advantages of Trading CFDs
There are many useful benefits involved with trading CFDs. Here are a few.
They can be traded on a wide range of assets and other financial instruments. This gives traders the option of making choices based on their preferences.
Trading, in general, can hinder many individual traders because of their high costs. However, for CFDs, the cost of entering the market is not high. Investors only need to put up a deposit, and then they can begin to trade.
Despite being banned in some regions, CFDs have attracted many investors globally. The added advantage is that majority of the brokers provide their services on major markets across the globe. This means that investors can access round-the-clock help. They are also able to access the market from anywhere in the world as long as the investor has a computer or phone with internet access.
Brokers usually have unique services. These services aren’t different when trading CFDs. Some unique tools that brokers offer include tools such as limits and stops. Some of the orders even have provisions for unforeseen and dependent orders like “if done”. The advantage of this is that these services are usually offered at no extra cost.
CFD investors get to enjoy the benefits of trading in that they only invest in a small percentage of the full value of the asset. This means that the traders can experience both the benefits and risks of trading without owning any assets. Contracts are settled in cash.
As much as many benefits come with CFD trading, there are many risks as well which traders should be aware of before beginning to trade.