CFD stands for ‘Contract for Difference,’ which means that two parties agree to pay the price difference without owning the assets. As the CFD’s value derives from the changing price in financial markets, it is called Derivatives. The CFD is a debatable topic these days. Some say that it is more like a gamble, which is resulting in huge losses. While some believe CFD to be a true financial instrument which is capable of bringing profits with proper planning. This article talks about the benefits and risks associated with CFD trading.
The benefits of CFD trading
- Leverage – CFD needs you to deposit a fraction of the trade’s value and in return, multiplies your gains. The deposit that you keep aside is called margin. The deposit that you will need depends on the margin and the size of your position. However, the only thing to remember is that your total profit or loss will be counted on the full size of your position, not on the deposit that you have made.
- Trading in the huge market – CFD can be used to trade over 16,000 markets, which include commodities, forex, shares, cryptocurrencies, and more. The benefit of trading CFDs is that you don’t have to access multiple trading platforms to trade in a different market. You can do it by logging in on one platform from any device including web browser, tablet, and phone.
- Hedging the share portfolio – If you own the shares of some company for the long term and you know that the company’ share value is going to drop, then you can use CFDs by opening a short position. If your prediction goes right, your CFD will bring profit, offsetting the loss that your shares were bringing with them.
Risks of CFD trading
- Leverage – Ironically, leverage is also the drawback of CFD trading. Leverage offers you larger exposure on small initial deposit. Leverage boosts both your potential profits as well as losses. When a market goes against your prediction, and your margin level drops to the agreed level, in that case, you can either deposit more funds or can close the positions partially or fully. It’s always better to place stop losses to reduce the trading risk.
- Market volatility – The financial market fluctuates quickly, which affects the price of the products. Gapping is one of the risks that are associated with rapid market volatility. Gapping occurs when one product shifts from one level to another level eliminating the levels in between. A trader might not get an opportunity to place an order between two price levels. This is why stop loss orders are not executed on the price levels that you haven’t thought of. To limit the risk, apply the order boundary and guaranteed stop loss order.
- Holding or overnight charges – Depending on the position that a trader holds, he may be charged holding charges or overnight costs. The holding charges are the cost that is applied to the account daily if a trader holds the position of certain products overnight. Sometimes these costs exceed the number of gains and can increase the losses.
Market volatility makes the CFD trading risky and a platform like AAATrade.com makes trading easy for the traders.