The acronym CFD means “contract for difference.” These are new types of financial products, recently developed by the limitless imagination of financial engineers. These products are called “derivatives”.They are always based on an underlying asset, like an option or a warrant. You can find CFDs trading on just about everything: from stocks to indices, including commodities.
The CFD market is growing very quickly, and today there are thousands of products available to investors. Some brokers have specialized in CFD trading.
Unlike warrants and options, there is no time value, you can stay positioned as long as you want on a CFD, and its value does not erode day after day.
The Importance of Choosing The Best CFDs Broker
Choosing the right broker is the getaway for the good and profitable CFDs trading opportunities. While making your choice, you will find yourself overwhelmed by the data. In a nutshell, what you should be looking for is a broker with as many assets as possible, great accessibility and low costs for processing transactions.
Since CFDs are complex instruments, traders must be sure that CFDs brokers are well regulated. To do so some reviews are updated every several months. There you will find all necessary info regarding the brokerage platforms.
What are the advantages of CFDs
A great ease for investing in a large number of assets that are not very accessible to individual traders: commodities, international equities, stock market indices, or currencies, for example.
- Unrestricted buying and selling in the short term. You can play very easily in both directions, up and down.
- Possibility of investing in multiple assets internationally with a small portfolio. The transaction costs are low, and there are many possibilities with a modest capital that the commissions would quickly eat up if we intervened directly on the shares.
- No time value, unlike warrants and options.
- Very high liquidity. The broker who insures the counterparty constantly quotes a tight buy and sell price on CFDs; you get in and out when you want at a reasonable price.
What are the risks of CFDs
There is only one; it is the leverage effect! That is why you always need to use CFD calculator before venturing into CFD trading.
One can easily invest large sums on CFDs and take positions up to 20 times greater than his/her liquidity. Beware of the high risk of losing money rapidly in the event of unbridled enthusiasm for leverage!
As we have detailed above, CFDs have many advantages, especially in a speculative investment approach. These are simple to understand products but need to be used with reason and well-established “money management.” Given the powerful leverage effects, it will be necessary to have a CFDs trading plan in mind at all times. Set stops, and don’t hesitate to cut the position if it goes the wrong way.
In general, you should take care not to be under-capitalized and tempted to use strong leverage. The risk will be perfectly controlled if you stay within low leverage levels. Investors with the smallest accounts (a few hundred euros) are often plucked by abuse of leverage after one or two successes. Do not be one of them and avoid the trap of too much leverage which is generally the biggest risk when trading CDFs.
The high liquidity and the absence of volume constraints will suit day traders. We recommend products from a short-term perspective by playing on volatile markets to capture brief market movements. More advanced users of CFDs will use them as a portfolio hedging tool or accessing markets with high entry barriers: oil and other commodities, stock indices, etc.