Many investors have become very interested in a type of trading instrument known as a contract for difference. Often referred to with the acronym CFD, there are a number of benefits to these unique options. Let us first examine the basic principles behind a CFD trade before looking at some of the advantages as well as a few potential drawbacks.
A Beginner's Guide to CFDs
As the name already hints, a contract for difference position is defined as a change in the value of an asset when the trade is entered and exited. However, a CFD only mirrors the movement of this asset; the investor never actually physically owns the product. To put it simply, this position is a contract (agreement) between the client and the broker. Now that we have a very basic appreciation of the principle behind CFDs, let us continue by observing advantages and possible pitfalls.
Benefits
A contract for difference is concerned only with the movement of an asset as opposed to its discrete value rising. For example, let us imagine that a trader believes that the value of the dollar will fall in relation to the euro within a set period of time. He or she will open a position based upon this belief and should the currency pair move in the predicted direction, a profit will occur. So, both positive and negative changes can be rewarding.
Anyone interested in maximising their levels of return will be pleased to know that a CFD is generally associated with higher leverages and lower margin requirements. Of, course, greater leverages can help to dramatically increase the levels of profits to be experienced within a winning position. Lower margin requirements dictate that significantly less capital will need to be provided (when related to a normal equity trade, for instance). CFDs are therefore popular options for those who understand basic market fundamentals and do not wish to financially overexpose themselves with a more traditional trading system.
Global access is a third windfall enjoyed by CFD traders. Platforms such as CMC Markets provide traders with the possibility to tap into all of the world's major financial markets. This can occur within a single centralised trading platform. A greater number of currency pairs allows individuals to enjoy more flexibility and naturally, the chances of enjoying healthy profits are substantially increased.
Potential Drawbacks
Of course, there are a few disadvantages to a CFD trade. Having to pay the observed spread during an entrance and an exit eliminates the possibility to make sizeable profits on small moves. Higher leverages can likewise be associated with the potential to lose more capital than was initially invested; an issue for those on tight budgets or who may not have a great deal of experience.
This is only a very basic guide to CFD trades. To learn more or to open up a trading account, it is wise to visit CMC Markets. With study and patience, CFD trading can be a very rewarding method.
