If you’re concerned about the pitfalls of owning stocks, then trading a contract for difference can be a wise alternative option. Hoever, just like other trading vehicles, there are advantages and disadvantages to trading CFDs. Investors who want to start trading CFDs need to completely understand them as a mechanism before entering the trade.
Pros of CFD Trading
- Lower Margin Requirements
Unlike traditional trading, CFDs provide much higher leverage. CFDs are traded on a margin, and margin requirements may go from as low as 2% up to 20% depending on the underlying asset. Lower margin requirements mean less capital outlay for you as a trader and greater potential returns.
- Easy Access To Global Markets
Since most CFD providers offer products in all the world’s major markets, it’d be easy for CFD traders to trade any market while that market is available from their broker’s platform.
- No Shorting Rules And Borrowing Cost
Short selling (shorting) is the sale of securities or financial instruments that are not owned by the seller, or that are borrowed by the seller. Some markets have rules that don’t allow shorting at certain times and require the trader to borrow the instrument before shorting.
Generally, the CFD market doesn’t have shorting rules. An instrument can be shorted at any time. Since you don’t own the underlying asset, borrowing or shorting costs don’t apply to you.
- Use Of A Stop Loss
A stop loss is an important trading mechanism that enables you to exit the CFD trade at a chosen point before your losses mount.
- Little To Zero Fees
CFD brokers, like traditional brokers, offer the same order types including stops, limits, and contingent orders. But unlike the traditional ones, many brokers don’t charge commissions or fees of any kind to enter and exit a CFD trade. However, the broker makes a profit by allowing the trader pay the spread (which is almost always a fixed spread). A trader must pay the asking price to buy, and take the bid price to sell.
- Variety Of Trading Options
Aside from stock, you can also benefit from various financial markets like index, commodities, currencies (forex), and treasuries.
Cons of CFD Trading
- Higher leverage
The smaller the initial margin, the higher the leverage – this is the downside of leverage trading. While the profits can be amplified due to small minimum outlay, the losses are magnified in the same way.
- Paying spread on entries and exits
While stocks expose their traders to fees, commissions, more rules, and higher capital requirements, the CFD market may cut their traders’ profits by way of larger spreads. Having to pay spread on the entry purchase and the exit sale can rule out any profits that have been made if there have been only small movements on the price. And when large price movements do not occur, it can be a waste of money.
- The CFD industry itself is not regulated
CFD trading is not standardized so it’s important to investigate whom to trade with. Any trades you make should be with a reputable CFD brokerage firm with an established financial history and position. Looking closely to which broker best suits your needs and trading goals is key to becoming profitable.
Author Bio: Sophie Harris is one of the resident writers for FP Markets CFD Trading, a CFD and Forex Trading provider in Australia with over 12 years industry experience serving global clients. Writing informative content about business and finance is her cup of tea.