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What is CFD Trading and How Does it Work?

By: SmallBizClub

 

Business trader team checking stock market online analyzing graph data on laptop screen to brainstorming about trading online while working together in office.

There’s a sense that the coronavirus pandemic and its associated lockdowns across the world saw a huge increase in the number of active financial market investors. Many of these were part-time and casual in nature, while they largely targeted speculative asset classes such as forex.

In terms of investment vehicles, contracts for difference (CFDs) also saw a marked increase through 2020. During this 12-month period, interest in CFD trading actually peaked by 193%, as people were drawn by the flexible nature of the product and its inflated leverage.

However, it’s estimated that around 82% of all CFD clients ultimately lose money. So, what exactly is CFD trading, and what are the benefits of this investment vehicle?

What Are the Benefits of CFD Trading Online?

The term CFD refers to a contract that exists between two parties, which requires them to pay the difference in a particular asset’s price between the opening and closing times of a position.

In this respect, CFD trading is speculative in nature, so it’s possible to profit even when a market depreciates as you won’t ever own the underlying asset. This affords you far more flexibility as a trader, as it enables you to go ‘short’ or ‘long’ and leverage market volatility to your advantage.

CFD trading can enable you to speculate on a number of diverse asset classes, including forex, indices, stocks and commodities.

Of course, CFD trading differs slightly depending on where you are in the world. This is particularly true in Australia, where slightly more stringent rules exist and terms such as ‘spread betting’ aren’t allowed to be used.

CFD trading in Australia is regulated tightly by the Australian Securities and Investments Commission (ASIC), which licenses domestic brokers and dictates the terms on which traders are able to operate.

CFD trading is thought to be particularly advantageous to new and inexperienced traders, but what are the main benefits of this investment vehicle? Let’s find out!

  • #1. There’s a Low Barrier to Entry: On a fundamental level, CFD trading is a relatively accessible investment vehicle and that has minimal barriers to entry. Certainly, you won’t need to own underlying assets as part of your portfolio, while it’s also possible to utilise leverage and trade on margin to open positions that are disproportionate to your deposit. As a result, you can trade CFDs with a small initial outlay.
  • #2. Increased Leverage: On the subject of leverage, some reputable brokers will enable you to open leveraged positions of 200x your deposit through CFDs. So, you can control sizeable positions without committing significant sums of cash in advance, increasing your potential returns in the process. Of course, you can also lose a disproportionate amount of cash, so it’s important to adopt a balanced approach that optimises the risk-reward ratio.
  • #3. Trade the Market 24/7: Through CFD trading, you can access your chosen market 24/7 between the hours of 5pm Sunday and 5pm Friday (CST). This creates tremendous flexibility in terms of when and how often you trade, which is ideal when speculating on real-time price shifts. While you cannot open or close positions over the weekend, you can execute stop losses, take profit and implement trailing stop orders during this period.

Author: Lewis Humphries is a writer, blogger and researcher from the UK. He specializes in the fields of finance, business, digital marketing and technology. He also has a passion for healthy living and exercise.

Published: June 22, 2022
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