The Pros and Cons of CFD Trading

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There is much debate these days about the validity of CFD trading. Some argue that as this investing mechanism is nothing more than another form of gambling, trading the financial markets by using it will just result in excessive losses. However, others take a totally different stance by adopting the viewpoint that CFD trading is a true financial instrument capable of generating a consistent stream of profits, if applied proficiently. So, what is the real story? This article sets out to identify the key advantages and disadvantages of CFD trading so that you can assess the situation for yourself.

 

The Benefits of CFD Trading

CFDs (Contracts for Difference) are classified as derivative because they provide you with the ability to speculate on the price fluctuations of a variety of financial securities without the necessity of purchasing any ownership in the underlying assets whatsoever. They are basically agreements between two interested parties, which are the buyer and the seller. Essentially, you can utilize CFDs to profit from the price variance of an extensive range of resources diversified among the four main trading categories, which are currencies, indices, stocks and commodities.

For example, if price of a particular security is ascending within a well-defined bullish trend, then you could evaluate the validity of purchasing that asset by using a CFD. The primary intention of such a move would be that you could then sell the CFD at a later time after price has appreciated in value in order to record a profit.

In addition, when you trade using CFDs you will have access to an extensive leveraging facility. You will therefore be able to open a very large position by supporting it with just a small deposit. For instance, imagine that your CFD broker provides you with a leverage of 100:1. You could therefore execute a CFD based on gold, for example, by initiating a $100,000 position backed by just a $1,000 deposit of your own money.

However, although leverage provides you with the opportunity to register greater profits it also increases the levels of risk substantially. As such, you are well-advised to master the concepts of money management as quickly as possible in order to optimize the protection for your account balance when trading CFDs.

There are many other exciting benefits about using CFDs to trade the financial markets. For instance, they allow you to profit from both rising and falling market conditions. In addition, any profits that you acquire from CFDs are also not subjected to Stamp Duty because you never own the underlying assets. Also, CFD brokers charge minimum fees and commissions for their services.

If you possess a CFD based on a firm then you are entitled to partake in the shareholding decisions of that particular company. You are also entitled to initiate an advisor facility with your CFD broker which will entitled you to receive expert advice about trading opportunities, etc.

 

The Dangers of CFD Trading

However, you will experience higher levels of risk when you trade CFDs than you do using other traditional forms of investing. For example, as ready stated you must adopt extreme caution when applying leverage because excessive usage can lead to overtrading and exposing your account balance to serious losses. How can you best prevent such problems? You can do so by designing and utilizing a sound and well-tested risk and money management strategy that will guarantee that you will never subjecting your equity to dangerous levels of risk.

You must also teach yourself to control treacherous emotions such as greed so that they do not influence the quality of your trading decisions. Unfortunately, CFD trading can easily seduce you into allowing this to happen because of its large daily turnover. This hefty value can readily confuse your mindset by making you instigate unsustainable large gambles.

In addition, CFDs are subjected to tax liability in the form of capital gains because they are classified as an investment. However, this status does have its advantages as you can offset your losses against your future tax obligations. CFDs are also liable to financial fees. For example, if you opt to rollover your position throughout the night, then it will incur an interest charge if it is a long trade. However, short positions earn interest which will be credited to your account.

 

Defining Other Important CFD Risks

Although there are significant benefits associated with trading CFDs, you must not ignore or dismiss lightly its many hidden risks. In contrast, if you acquire an extensive appreciation of theses lurking dangers then you can prepare yourself to counter them better by implementing appropriate strategies. The following list identifies a number of important CFD risks:

1.       Constructing CFDs using unfamiliar assets.

2.       Exposing your account balance to excessive risks by overtrading.

3.       Not understanding the negative impacts of leverage.

4.       Activating CFDs by trading against the prevailing trend.

5.       Succumbing to greed after experiencing a bout of consecutive wins.

Essentially, CFDs offer you a powerful method to trade the financial markets as they possess a number of exciting benefits and advantages, as described above. However, you must adopt a professional trading attitude when doing so in order to counter the risks involved.

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