CFD’s have become one of the world’s most popular and profitable trading products for active traders in the past 10 years. Why? Because CFDs provide easy access to trading stock markets all around the world, more leverage, more control, and also a very cost effective way to trade.
A contract for difference or commonly referred to as CFD is a contract between two parties, a buyer and seller to exchange the difference between the opening and closing price of a share. CFD’s are very easy to understand and trade. In fact, it is exactly like trading shares but the main difference is the trader doesn’t own the shares. CFD trading allows traders to purchase the right to buy or sell shares in a given stock at a certain price for a pre-determined period of time.
There are many benefits of trading CFD’s instead of trading regular stocks. The main benefit of trading CFDs is the easily available access to leverage. Leverage means that you only need to deposit a percentage of the value of a stock position to secure the trade which gives you the opportunity to diversify your portfolio by freeing up more capital for other trades or to boost your profits. CFD’s use the power of leverage to trade and typically needs an initial margin of 1-5% of the total value of the trade to enter the position. Here is an example of the power of leverage using CFD’s.
Let’s say you have $10k to trade the stock market and believe the stock price of Apple (AAPL) will continue to go higher. It is currently trading at $185 and based on your $10k capital, you can only buy 50 shares. A few months later, Apple’s stock price goes to $200 and based on your 50 shares, you make $750 or 8%. However, if you were using CFD’s to trade, typically trading on a 5% margin, you have access to $200k of purchasing power based on your $10k capital and are able to buy 1,000 shares of AAPL. When the stock price went up to $200/share, you made $15,000 or 150%. As you can see the profit received after using leverage was far greater than without.
Also, CFD’s allow you to be able to easily trade any stock market around the world including the United Kingdom, The Netherlands, Germany, Switzerland, Italy, Singapore, South Africa, Australia, Canada, New Zealand, Sweden, France, Ireland, Japan, Hong Kong and Spain. Unfortunately, CFDs are not permitted in the United States, due to restrictions by the U.S. Securities and Exchange Commission (SEC).
Also, CFD’s provides a convenient way for traders to profit from a falling stock market where trading ordinary shares may not. The concept is called selling short which means you borrow shares of a stock and sell it in the expectation that you can buy back the shares at a lower price. The trader hopes to profit from a decline in the price of the stock between the sale and the repurchase, as the trader will pay less to buy the stock than he received on selling them. With CFD’s, you don’t have to worry about borrowing stock and with a simple click of the sell button, you can easily make money when the stock market goes down.
Lastly, CFD’s are very cheap to trade as they typically have very low commissions or no commission at all. This is an extremely important concept for active traders.
There is a disadvantage of trading CFD’s which you need to be aware of. One thing you need to be careful is playing with too much leverage. Leverage can help you make a lot of money but it can also cause you to lose all of your capital if you are not careful. As well, there are interest charges on the leveraged capital that you are borrowing from the brokerage firm. If you hold a stock for a long period of time, you can pay a lot of interest.
If you are a trader who wants to make lots of money in the stock market, you can consider CFD’s as a tool for you to achieve your goal.