If you’re new to the world of foreign exchange, you may have seen or heard the term “CFD.” What is CFD and how does it work?
In simple terms, a CFD is a contract between you (the client) and the broker. In most cases, that broker is a trading platform such as this one.
CFD stands for “contract for difference.” Considered a tradeable instrument, it follows the movements of its underlying assets. CFD is what allows for a profit or loss when the underlying asset moves in relation to the chosen position. However, you never actually own the underlying asset.
The Advantages of CFDs
There are many advantages to trading CFDs, including:
Day Trading Rules Do Not Apply
There are often restrictions with day trading, including minimum capital requirements and limits on the number of day trades that can be made with accounts. None of these requirements apply to the CFD markets, so investors are free to day trade if they wish.
With that said, most brokers will require a deposit of at least $1,000, with some requiring as much as a $5,000 deposit.
There are Multiple Trading Options Available
There are a variety of trading options available in the CFD market, including index, stock, currency, treasury and commodity. CFDs can be a useful tradeable instrument for not only stock traders, but investors of a variety of financial vehicles.
CFDs offer higher leverage than conventional trading. Standard leverage can begin at as low as 2% and may go up to 20%. With a lower margin requirement, less capital outlay is required of the investor, but higher leverage can also mean bigger losses.
When trading CFDs, you will incur few (if any) fees. In most cases, brokers never charge fees or commission when entering or exiting trades. Rather, money is made when the trader pays the spread.
The Drawbacks of CFD Trading
Just like any other tradeable instrument, CFDs also have their drawbacks. One of the biggest drawbacks is having to pay the spread when entering and exiting trades. Having to pay the spread means small moves won’t give you a profit. Winning trades are also slightly decreased because of the spread.
Another important thing to note is that the CFD market is not highly regulated. For this reason, it’s incredibly important to use a reputable broker that will meet your trading needs.
With that said, CFDs have their advantages and serve as a great alternative when making certain types of trades.