Contract for difference (CFD) trading is a short-term financial agreement between a trader and a broker. After the contract, the broker pays the trader the difference between the opening and closing positions of a specified currency pair. Depending on the direction taken by price movement, CFD trading can result into a profit or loss. If you are the trader and the price moves in your favor, you stand to gain.
However, if the currency price moves against you, you stand to lose. CFD trading is popular in the forex market with many reputable brokerage firms using it as a trending strategy. The firms use the trading strategy to protect your trading account by limiting any heavy loses that would put your account into debt. They do this by offering negative balance. CFD trading has many benefits but it also comes with some limitations.
Benefits of CFD Trading
1. Allows Leverage/Margin trading
One of the key benefits of trading CFDs is that it allows you to trade leverage. What this means is that you can use a smaller amount of capital to control a much larger trading position. The lower the margin needed for investment the higher the chances of potential profits.
2. Gives you room to go short
Short selling is a trading strategy many traders take advantage of especially when the prices in the market are falling. A CFD platform provides an investor with both the buy and sells prices. When the prevailing currency price conditions indicate an upward trade, you can trade with the buy price. If there is an indication of a potential downtrend from the prevailing market conditions, you can trade with the sell price.
Short selling involves borrowing an asset hoping the price will go down so you can make a profit later by buying it back. The strategy takes advantage of an unexpected currency price. Whether the currency price declines or goes up, you will most likely gain profit from the trade. The short selling strategy is challenging to execute with other products that are not derivatives.
3. Allows trading a wide range of markets
Trading CFDs provides you with an opportunity to trade different markets that include digital currencies, forex, currencies, indices, commodities, shares, stocks and energy. You can also trade CFDs from a wide range of devices, which included mobile phones. CFD is accessible in only a single login, which saves you the trouble of login into multiple platforms when you need to access each portfolio.
Some brokers also offer their traders an around the clock trading platform allowing them to access their portfolios anywhere and at any time. Even when the currency prices are changing fast, you never miss valuable trading opportunities.
4. Offers instant order execution
Unlike traditional brokers that take days to settle trades, a CFD platform offers you instant order execution. With this, you can instantly open and close positions, which provide you with the ability to react to market conditions in a better way and get more trading opportunities.
5. Low fees and commissions
Most CFD brokers do not charge anything to open and close trading positions. All you pay for is the spread and you are good to go.
Limitations of CFD trading
CFD trading speed is very attractive which can lead to over trading, which is a serious mistake to make. Trading without having your emotions in check just because the speed looks too good easily leads to tiny profits from bad opening and closing positions.
While leverage is the key advantage of CFD, trading it can also be a disadvantage. The same leverage that can give you substantial profits when the trade positions are in your favor can also start to eat rapidly at your capital if you do not get the leverage balance right.
The key to minimizing the risk is to reduce the leverage impact when positions do not go your way by using a slow and steady CFD trading approach. Some uncouth brokers might also take advantage of new CFD traders by offering trades with high leverage in the hope of gaining from the trader’s loss.
3. Financing fees
Even if opening CFD position is free, some brokers might charge you financing fees if you keep an open position overnight.
Trading CFDs might be challenging for a newbie but with a committed and trusted broker, it is one of the simplest trading strategies. If you want to be on the safe side, you should choose a trading platform that provides you with the preference of using a demo account to help get a better footing at CFD trading. It is great strategy with many benefits but it has its risks that you can avoid if you trade with caution.