Contracts for Difference (CFDs) are a separate category of derivatives. One of the main features of a CFD is the ability to speculate on the performance of a market, such as a stock, currency pair, etc., without owning that market. CFD trading is a popular form of trading because it offers traders a variety of opportunities. We want to give you an understanding of these by means of the advantages and disadvantages of CFD trading.
Advantages of CFD trading
1. The trader has access to all financial markets from one account.
Most CFD brokers offer their clients extensive access to the various capital markets of the world. These can be divided into the categories equities, indices, currencies (Forex), commodities, interest rate and bond markets and, in the meantime, crypto currencies. In addition, most brokers offer their clients the possibility to access the trading platform and their own positions via a mobile app.
2. CFDs are available for most instruments around the clock;
Since the prices of the respective products are derived from the underlying markets, the trading hours are usually linked to the opening hours of the exchanges. However, since there is no break in trading, for example in global currency trading, except on weekends, traders can trade their positions around the clock.
3. A trader has the opportunity to invest in CFDs and hold his investment as long as he wants (no time limit);
Since CFDs, unlike warrants or certain certificates, have no maturity on a certain date, the positions taken can be held as long as a trader wishes according to his analysis.
4. The product of the CFD allows the trader to open positions on both rising and falling markets. This makes the CFD one of the most flexible products in trading. The investment horizon of a classic investor, for example in equities, doubles through the use of a CFD because in classic equity trading profits can only be achieved with rising prices.
If a trader thinks that the price for a security rises, he opens a buy position or he “goes long”. If the trader thinks that the price of a security is falling he opens a sell position or he “goes short”.
5. A trader can speculate with an amount greater than his actual capital as the CFD leverage exists. Through the use of CFDs the trader is able to increase his investment capital. This is possible because the trader only has to deposit a fraction of the actual order volume moved in order to open a position. This deposit is called margin.
6. A trader benefits from very low CFD fees.
Compared to competing financial products, the CFD benefits from a low but above all clear and comprehensible cost structure. With most providers, there is a classic order fee in the form of a commission only when trading shares via CFD. For all other CFD markets, the order fee is already included in the trading spread, i.e. the difference between the buying and selling price. If positions are held overnight, only the financing costs for holding the position are added.
7. A trader can hedge his physically held positions, e.g. in shares or gold, with CFDs.
CFDs are a perfect instrument to hedge your existing equity portfolio against falling prices. This process is referred to as hedging. Most investors plan to make profits with their physical shares in the very long term. Not least through the annual dividends distributed. However, should there be a short-term decline in share prices, the losses in the physical stocks can be perfectly hedged by, for example, short positions as CFDs.
8. A trader is protected from a negative balance on his account.
With brokers domiciled and regulated in Europe, every private client is protected from a so-called obligation to make additional contributions. This means that a client can never lose more on the capital market than his account has as capital.
Disadvantages of CFD trading
- the leverage effect already mentioned in the advantages, which makes CFD trading very capital effective, can of course have a negative effect on the trader in the same way. This happens if the trader was wrong in his analysis and the market develops against him.
- A lack of training or knowledge about trading CFDs can be quickly penalized in the fast moving capital markets of the world.
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