CFDs

How Do CFDs Work?

CFD brokers will generally charge a spread on each position, which refers to the difference between the price to buy and sell the asset. For example, let’s imagine a CFD trade using shares of corporate stock. When the CFD trade is first opened, the trading account will show a negative figure (a loss) that is equal to the broker’s spread costs. Prices will need to move in the direction of the trade in order to become profitable, and this is different from a more traditional stock trade where broker commissions might be charged before the new trade can be established. In most cases, broker commissions are higher than the spread costs charged in CFD trading. As a result, CFDs can provide significant cost savings when we consider that many trades are likely to be placed over the lifetime of a trader’s career

Another advantage of CFD trading is the ability to use higher leverage when compared to traditional trading techniques. In CFD markets, standard leverage demarcations are subject to official regulation. In the past, 2% margin requirements defined standard leverage levels (or a ratio of 50:1). More recently, these requirements have changed and limitations have set standard margin requirements with a broad range of 3% to 50% (or leverage ratios of 30:1 to 2:1). These differences are somewhat significant, so it is important for traders to understand their broker’s leverage requirements before starting a live account.

Using a single trading platform, CFD traders are able to access markets at the global level. CFD trading is not limited by rules on shorting or borrowing (which can be an unfortunate feature in certain stock markets environments). CFD brokers will typically provide traders with access to the same order types that characterize traditional trading instruments (such as stop-loss orders, contingent orders, or limits). In some cases, the market’s best CFD brokers will even offer guaranteed stop-loss orders, which will trigger even when market volatility reaches extreme levels. However, this is not always the case, so market traders must fully understand their broker’s individual terms before opening live trades through any platform.

Certain capital markets have established requirements that define minimum margin levels or limit the number of day trades that can be placed over short periods of time. However, these restrictions are not in place for CFD traders because they can initiate as many day trades as they want to make. Since minimum margin levels are not a concern in most cases, CFD traders are often able to open accounts with a small funding balance, as minimum deposit requirements of $5,000 or less are not uncommon.

Managing Potential CFD Trading Risks

One of the disadvantages of CFD trading is that traders must pay the spread costs. However, all forms of trading require fees of some sort, and the spread costs that are associated with CFD trading are often much lower than they would be when using more traditional investment vehicles. For these reasons, CFDs are usually not the best choice for anyone that is looking to trade on small time frames. Additionally, the CFD trading industry is generally characterized by weak regulation which means that broker reputation can be very important for trader success. Factors like the financial position of the company and a long track record can be viable elements when selecting a CFD broker. Of course, there are many great CFD brokers available in today’s markets but it is very important for traders to research the background of each broker background before making a selection.

CFD markets are often fast-moving and this activity requires that traders closely monitor their trading stations for new developments. Increased leverage risks can significantly raise profit potential for traders but this is a practice that can also expose traders to greater profit potential when used appropriately. On balance, the ability to use leverage should be viewed as a positive because it improves trading flexibility.  As a result, there are many advantages that can be found when CFD trading (such as low margin trading requirements, no limitations placed on day trading or short positions, efficient access to world financial markets, and trading costs that are close to zero in many cases). Each of these elements can help add to the wide variety of market trading opportunities that are available for global assets and this is precisely the reason CFD trading has become so popular in recent years.