A contract for difference(CFDs) is simply a financial instrument that gives traders and investors an opportunity to profit from price movement without owning the underlying asset. This is accomplished through a contract between client and broker and does not utilize any stock, forex, commodity or futures exchange. And according to Investopedia, trading CFDs offer several major advantages that have increased the instruments’ enormous popularity in the past decade.
Advantages of Trading CFDs
1. Higher Leverages
Trading CFDs provide higher leverage than traditional instruments. You can start with as low as 2% margin and as high as 20% margin. However, increased leverage can also magnify losses(Leverage is a 2 headed sword).
2. Global Market Access
Most CFD brokers offer products in all the world’s major markets.
3. You Can short CFD
CFD instruments can be shorted at any time without borrowing costs because the trader doesn’t own the underlying asset.
4. No commissions or execution fees
Most CFD Brokers make money when the trader pays the spread and do not charge commissions or fees of any kind. To buy, a trader must pay the ask price, and to sell/short, the trader must pay the bid price.
5. Variety of Trading Opportunities
Brokers currently offer stock, index, treasury, currency, sector and commodity CFDs so speculators in diverse financial vehicles can trade CFDs as an alternative to exchanges.
Disadvantages of Trading
1. Traders Pay The Spread
It eliminates the potential to make a profit from small moves since traders pay the spread on all entries and exits.
2. Less Industry Regulation
Also note the CFD industry is not highly regulated, therefore, it’s very important to investigate a broker’s background before opening an account.
The take away from this article is that despite the variety of opportunities that can be derived from trading CFDs(shorting, no commissions, higher leverages), it’s important to carry out a background check on your broker since the industry is not well regulated. Also, trading CFDs may not be profitable if there’s no huge movement in price because you pay spread on all entries and exit trades.
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