Is a contract for difference right for you? Different traders have different aims in the market, and some strategies require specific techniques and approaches, so it's difficult to answer this question definitively.
But what is CFD trading, and how does it work? Read on to learn more.
A CFD stands for contracts for difference — a trading instrument popular among novice and experienced traders.
When you take out a CFD, you speculate on the market’s future. This means traders don’t need to take ownership of the asset to trade it. You simply enter into a contract that predicts future market movements.
CFD products have several distinct advantages over other traded markets, such as:
CFD products have several distinct advantages over other traded markets, such as:
| CFDs | Stocks | |
|---|---|---|
| Transaction costs | Low | Higher |
| Leverage | High | None or low |
| Volatility | Often volatile | Infrequent volatility |
| 24-hour market | Yes | No, market closes |
| Automatic trading | Available | Not available |
Is CFD trading the right choice for you and your situation? This depends on your aims as a trader and your strategy.
CFDs can be relatively straightforward, and their low investment requirements may make them attractive to beginner traders. However, while appearing simple, contracts for difference can be more complex than meets the eye, particularly futures, forwards and options that carry time parameters and transaction obligations. Even simpler spot trades are subject to market forces, and the market can move unexpectedly.
It is wise for beginners to grow their experience before risking capital on real live trades.
Share traders can use CFDs to execute stock market positions without purchasing shares themselves. Share CFDs can be opened and closed quickly in the short term, providing potential profits quickly as long as the prediction is correct.
CFDs enable share traders to profit whether the market is moving upwards or downwards. Traders might not want to wait for a market upturn before they make a move and may prefer to speculate on a short position. They can do this with CFDs, as they specify the price difference.
However, share traders should keep the spread in mind when they open a position, as this is the price they need to pay to control the trade. The spread means traders lose some of their stakes the moment they open their position, but the market is so volatile that they can make this back and quickly turn a profit.
For many Forex traders, CFDs have become a crucial access point to the foreign exchange market. No foreign currencies are exchanged — traders simply speculate on the market price changes they expect to see over time.
Traders can open a long or buying position if they expect the value to increase, or they can open a short position or a selling position if they expect the opposite. Combined with a highly liquid market, this flexibility is a key factor that attracts traders to forex CFDs.
As the forex market tends to be less volatile than the crypto market, the stock market or the indices market, forex traders may decide to maximise exposure by opening CFD positions with leverage.
Of course, traders can use CFDs in many other markets, including precious metal or oil trading.
