In this guide, we’re going to show you what is CFD trading and how it works in real life examples We will explain its main advantages and disadvantages, and how you can get started with CFDs.
What is CFD Trading
CFD trading usually happens with an online CFD broker like Pepperstone. You can exchange the price difference of your asset between when you opened the contract and when it closed. You only put up approx. 20% of the contract cost (margin) and gain full market exposure as if you had 100%.
CFD trades often enjoy lower fees and commissions. And in the UK, they are exempt from stamp duty taxes. Don’t forget to check out our review of the best cfd brokers in UK.
What are CFD contracts ?
CFD stands for a contract for a difference. Rather than buying into the underlying asset of a company’s stock, this financial derivative is an agreement with a CFD broker. This means that without buying the underlying asset, you can speculate on the financial instrument, whether they rise or fall. Your broker will buy the underlying asset on his behalf, and he will borrow it to you for a small fee. Eventually you as a trader will either profit or lose money on the trade.
How CFD Trading Works
CFD trading is all about buying and selling contracts for difference with profit or loss. You need to know whether the price of financial instrument will rise or fall. You need to predict the price movement, and based on that you need to either go “Long” meaning buy the CFD contract or go “Short” which is equal to selling the CFD.
This is different from trading stocks in which you buy into an asset. With stocks, you need the asset’s stock to increase for you to profit. CFD trading is different because you can trade long or short.
What’s the Difference Between Long vs Short Trading
Long or short CFD trading refers to whether you’re buying and speculating that the markets will rise or fall. A long position means that you are betting on a rise in profits, so you’ll gain when there’ an upswing in the market. Trading a short position is when your contract profits from the markets falling, so any fall in price is money in your pocket!
Here’s an example. Let’s say you want to open a long position on Meta shares. You decide to purchase 100 CFDs at $160 with a total value of $16,000. If Meta share appreciates to $170, you make $10 per share and a total of $1000.
The Pros and Cons of CFD Trading
- Leverage – Although you only put up 20% of the costs, your profits will be based on the full market value. That means huge profit when you do well.
- Find opportunities in both rising and falling market – With long and short positions, don’t wait around for the perfect stock. You can make money when you know an asset will fall!
- Instant Order Execution – Open and close contracts with ease. Make decisions about your assets that will take effect almost instantaneously.
- Leverage is doubled edged sword – How can leverage trading be both a good and bad? Well, while your profits are magnified, your losses will also be bigger when you’re wrong about your speculating. While stocks will rarely fall to zero, you can truly lose everything you invested with a bad leveraged position.
- Risk of Over trading – Because you can open and close CFDs so quickly, you may fall into the mistake of over trading. Make sure you truly evaluate each CFD you open and make an informed decision for when to close.
- Margin Call
The Risks of CFD Trading
Now that you have a better understanding of CFDs, it’s time to decide if it’s right for you. We think that you’ll enjoy the instantaneous orders of opening and closing contracts to speculate when the market rises or falls. This can lead to bigger profits from smaller investments, which you can’t get from stocks!
But it’s also important that you are aware of the drawbacks. Watch out for leverage trading from a poor position as it can lead to losses of your investment. And avoid overtrading by making informed decisions carefully.
Is CFD Trading Worth it ?
If you’re ready to start CFD trading, you need to be prepared to learn a lot of new things and master the effective trading strategies. As in any business that is worthwile, there is a steep learning curve. Do not forget to start on a demo account first.