A Contract For Differences (CFD) is a leveraged financial instrument which helps a trader profit from price movements of the underlying asset. The asset can be a Stock index, a stock, commodity, forex or any other instrument commonly traded on exchanges.
The CFD mimics price movement of an underlying asset, which means the value of a CFD generally rises and falls in tandem with the price of the underlying asset.
Is CFD trading good?
There are several reasons why CFDs are a very popular trading product. The very best CFD advantages are shown as follows.
CFD offers Leverage benefits
The most popular benefits of CFD trading relate to it being traded on leverage. This leverage is typically 20 to 1, with some CFD brokers providing 200 to 1 leverage.
This aspect of CFD gives immense advantage to a trader with a small capital. He can make decent profits from trading the stock market using CFDs.
CFDs are leveraged instruments. It means you can substantially take a position with a small deposit. You will often be able to buy or sell 1 lot with just 5% margin.
Having said that, the extent of leverage in both CFD trading and spread betting differs amongst brokers.
For instance, you may have a stock trading system that makes a 20% return per annum. On a $1000 account balance, this is $200 profit in one year. If you rather trade CFDs at leverage of 20:1, the same system can now produce a 400% return, which is roughly equal to $4,000 profit in one year.
CFDs are Direction-neutral
You can just as easily short sell CFDs as well, and therefore profit from falling markets. This and other such benefits of CFD trading greatly increase the profitability of a trading system.
Trading opportunities increase dramatically along with the fact that you can profit from both bull and bear markets.
With CFDs, a trader can take both long or short positions. There is no restriction in quantity traded, direction intended. Even short selling is completely allowed.
CFD offer low trading costs
The costs in CFD trading are relatively low when compared to stocks. This turns out as huge CFD benefits since for a similar and often smaller cost per trade, you can profit 10 or more times from a trade due to the leverage available.
However one of the two main costs in CFD trading is due to leverage. No stamp duty is applicable for CFD trading because you do not take ownership of the underlying assets when you trade either.
CFD trading has allowed traders to have a low cost exposure to equity price movements which is especially important for the traders bottom line.
Depending on which country you are in, CFD stock trading generally attracts no stamp duty, STT or other types of taxes. As mentioned earlier, the CFD Trading costs are reduced or increased based on taxes and duties.
Set automatic stop losses
CFDs help you to set up automatic stop losses. This and other such CFD advantages ensures it takes you far less time to trade, remove the emotion from exiting a trade, and allow you to exit just when the stop is hit, not a day later. You therefore avoid the slippage due to getting out of a trade later than when you intended.
This is one of the biggest benefits of CFD trading and is in fact a huge disadvantage of Mutual Funds. There is no provision to place a stop loss in Mutual Funds. You have to keep a regular check on your MF investment to make a profitable exit.
One of the best CFD advantages is that you can place all your CFD orders even when the underlying asset markets are closed. With many CFD providers, you can place orders to enter a position even at night. This is a boon for part time traders, having a full time job.
As other benefits of CFD trading, you can invest in different markets like stocks, gold, FX, ETFs, and options. CFD traders can also expect round the clock access to worldwide markets thanks to latest finest trading platforms and Direct Market Access (DMA). This is completely unlike Mutual funds where you get just one end of day price and have to invest based on that price alone
This is a great CFD advantage as they can do all trading (place their orders to enter and their stop losses to exit) in the evenings, and not need to be at the computer screen or call their broker during the day.
Also, if they have any stop losses that need adjusting, they can do so at night as well. Their trading routine with a mechanical system can be about 10-15 minutes per day.
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So these are the best 5 CFD advantages that have made trading accessible to so many people because they provide large returns for a modest capital, and can also be traded once a day as well.
I hope you enjoyed reading this article. In subsequent articles in this CFD trading series, I will explain more on all the above-mentioned points and write more on some advanced topics.
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