Benefits and risks of CFD trading compared to other trading types

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Broker 2020!
    Perfect For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-up Bonus Now!

  • Binomo
    Binomo

    Good Broker For Experienced Traders!

CFD Trading

What is CFD Trading?

CFD trading is a term used in trading markets referring to Contract For Difference, which is the agreement between two entities to exchange the entry and exit process of a trade. The contract for difference mirrors the underlying asset making it a tradeable instrument. Therefore as a CFD trader, you will make a profit or loss when the underlying asset moves in relation to the position you take even though you do not own the actual asset.

CFD trading is often a contract between clients and brokers. You do not have to buy or own the underlying instrument, and you just trade on what you expect to be its price movement. With CFD trading, you can profit from falling prices by either selling or offsetting potential losses in your investment by hedging your portfolio. You can find so many markets to trade and CFD allows you access a higher level of exposure in trading. You can deal with CFD is shares, currencies, commodities, forex, indices and many more.

How CFD Trading Works

  • Going long or short

In CFD trading, you can choose to sell, go short, if you predict the market price will fall or buy, go long if you predict that the market prices will rise. If you sell, your profit increases with any fall in that price, even if it is just by a couple of cents. However, if the market moves against the position that you take, your loss will also increase. CFDs enable the trader to benefit from any move whether market process is rising or falling.

You can use CFD to hedge your current trading portfolio. If you predict that your portfolio will lose some of its value, you can go short on your CFD to offset the loss. An example, if you own $300 worth of shares in a certain company and predict that the price of these shares will fall, you can go short on the equivalence of $300 CFDs. Therefore, whether the prices of these shares eventually fall, whatever losses you make in your shares will be offset by the profits you make while going short in your CFD trading. As an investor, CFD can be very valuable for hedging in volatile trading commodities.

CFDs can also be tax efficient for offsetting Capital Gains Tax Liabilities in losses. However, this depends on your circumstances and you need to get independent investment advice.

With the nature of CFD trading, it is important to have your eye on the markets on a 24-hour basis. You can trade whenever you want, 24 hours a day, seven days a week. In the volatile markets, prices move very quickly and 12 hours could make a world of difference.

Margin refers to paying a portion of the total value of the trade to open your position in the CFD. This kind of leveraging in CFD trading helps to magnify returns on investments. This is because the full trading exposure is more than the portion deposit you made to open your position. The only risk is that losses are magnified in the same way if the market moves against your position. In fact, you stand to lose more than the capital you put in. It is important to have risk management strategies in place when it comes to margin and leverage.

Cost of CFD trading

Various costs are involved in CFD trading. They include

  • The spread: In any trading market, you need to pay the difference between the buying and selling price, which is called the spread. CFD trading is no different. The cost of the spread depends on how narrow the differences between the entry and exit prices are. Narrow spreads mean you only need the price to change slightly in your favor in order to make a profit.
  • The holding cost: Any positions still open in your account at the end of the trading day may be subject to a holding cost. The end of the trading day is usually 5 O’clock New York time. The holding cost is negative or positive depending on the holding rate and the direction of your position in the CFD.
  • Commissions: If you are trading in share CFDs, you may be required to pay commission charges.

Benefits & Risks of CFD Trading

There are many reasons why Contract for Differences has become a popular tool for trading over the years. CFDs are slowly replacing traditional stock trading as most people consider them cost effective, flexible and transparent. Let’s look at the main advantages, along with some of the risks of CFD trading.

The Benefits of CFD Trading

Easy to understandContract for Difference (CFD) are a very simple to understand trading instrument. This is especially true for investors who are already familiar with share trading. This is because the prices of shares and the price of CFD usually move together. You just need to understand these price movements.

Get profits in volatile marketsWith CFD trading, you can benefit from any market conditions. You can make huge profits when the markets fall by going short. You can do this by selling a CFD on a share that you do not own. When the market conditions are not so good CFDs allow you to make profits and the good thing is that they do not have expiry dates like other financial instruments such as stock options.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Broker 2020!
    Perfect For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-up Bonus Now!

  • Binomo
    Binomo

    Good Broker For Experienced Traders!

Low commissions and marginsCompared to stock trading, where the broker requires you to pay the entire amount for the transaction, CFD trading has very cheap commissions. You are only required by the broker to deposit the amount required for the deal. In most cases, this amount is much less than 10% of the total cost of a transaction.

ConvenienceA single CFD trading account can be based on stocks, commodities or indexes. You are the one to choose the type of underlying asset you would wish to invest in.

Hedge other investmentsAnother benefit of CFD trading is that it can help you to protect your portfolio in case of price drops. The fact that you can go short or long whenever you find it suitable allows you to ensure your assets against poor market conditions. If you have a long-term portfolio that has been exposed to some short-term risk, you can use a CFD to hedge your position. This means that the returns you get from your CFD can cover for any losses in your portfolio.

Choose from thousands of financial marketsWith CFD trading, you are able to choose from thousands of financial markets. You can invest in commodities like gold or oil as well as equity and currencies on the Forex market. You are even able to access markets such as stock indices and interest rates that are usually unavailable to retail investors.

Leverage your returnsCFDs can allow you to make significant gains with less cash as an initial investment. You can trade on the markets having a deposit that is significantly lower than the value of your trade. You are only required to pay a certain percentage of the total transaction as a margin deposit which makes it affordable to most retail investors. This ability to trade with leverage is what makes CFD trading a lucrative financial instrument.

Risk managementEven the best investors will always find themselves at situations where their speculations were wrong and the markets are moving against them. CFD trading can help you to manage risks effectively and stop losses or limit the impact they have against you.

Check out our review of one of the leading CFD Trading software’s, is it any good?

The Risks of CFD Trading

Although there are as we have said, a number of benefits to trading in CFD’s, there are of course risks

Not Suitable for Long-Term Investment

CFD’s are not suited for long-term investment. By holding a CFD open for a long period of time, you will see the associated costs involved, increase. This will have a negative effect on the return you could expect.

Counterparties

A counterparty is a company that provides the actual asset in the CFD trade. Whenever buying or selling CFD’s it is the asset that is actually being traded in the contract provided by the CFD provider. What this means is that you are exposed if the counterparty fails to fulfill their financial obligations. In the event that the provider is not able to meet their financial obligations, the value of the asset is no longer relevant and becomes worthless.

The Markets

Just like any other type of investment, i.e. shares or forex, the value of your trade is completely dependent on the movement of the market. Because of the nature of CFD’s, even the smallest movement in the market can have a huge impact on the returns obtained. If there is a negative effect on the value of the asset, the provider may request what is known as a second margin payment. If this occurs and the margin payment can’t be paid, you may have to sell at a loss.

Liquidity

In the event that there are not enough trades being made on a particular asset, your contact may result in becoming illiquid. What this means is that the asset can’t be sold or exchanged easily without there being a substantial loss in the assets value. If the asset happens to become illiquid, the CFD provider could require additional payments or close contracts at a lower price.

There are further risks so it is important to remember that CFDs are in fact a leveraged product. This means that the result you get could be the loss of your entire capital. Trading CFDs is not for everyone, in fact if you are a beginner in trading, it may be best to get trading experience first before dealing in CFD’s.

It is important that you note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you can afford to take the high risk of losing your money

What Are CFDs (Contracts for Difference) and Why Do You Want to Trade Them?

CFD or Contract for Difference is a financial instrument that doesn’t involve the purchase of the underlying asset. The investor’s goal is to predict the direction of the future price movement and capitalize on the difference between current and future prices.

In general, CFD trading means you must close the deal in future to get either profit or loss in result. Forget about expiration time – you can close your deal at any time you want.

If the prediction is correct, the trader will earn a profit. The amount of it will depend on conditions of each particular deal. This makes difference between options and CFD trading, because while trading binary, classic or digital options you may just wait for expiration time and the deal will close automatically.

In CFD trading there is no expiration time. But you are able to set stop/loss and trigger a market order if the price gets a certain level.

CFD forex trading on IQ Option

Why to trade CFDs?

CFD is an alternative way of trading, which has its own advantages and disadvantages. When compared to more conservative trading tools, contracts for difference can boast the following benefits:

Margin trading. Contracts for difference offer the usage of a multiplier, an extremely powerful trading tool. With it, one can control the position that exceeds the amount of money invested in it.

When picking the 10:1 multiplier the trader gets an opportunity to open a $1000 deal with only $100 at hand. The other $900 would be automatically provided by the lender. What are the benefits and risks of trading on margin? The potential profitability (as well as risks) will also be magnified. Imagine investing $100 and getting the return that is comparable to a $1000 investment. That’s the opportunity a multiplier can offer. However, remember that the same goes with potential losses as these would be multiplied as well.

Fast trading. Trading on CFDs does not require massive time commitment and can be practiced both professionally and casually. Of course, for tangible results it is required not only to spend enough time on trading but also to undergo an in-depth training. Still there is a possibility of executing several deals spending less than 15 minutes a day, which certain traders will find beneficial.

Available CFD types

New CFD types, available in the IQ Option trading platform include CFD stocks, Forex and CFD cryptocurrencies.

Forex

The Forex market is the world’s largest and most liquid financial market. When performing the exchange of currencies, you’re expecting the price of a currency will grow and you’d be able to sell it back to make some profit off of that price difference. This kind of price speculation is the basic principle behind trading on the Forex market. For quite a while Forex trading was available solely to institutional investors such as banks, yet the development of the Internet let ordinary people join the international currency market.

Cryptocurrencies

The hottest trend of the trading season, cryptocurrencies drew the attention of both finance professionals and regular people. Now you also have a chance to capitalize on the movement of the six most popular cryptocurrencies.

Bitcoin has been growing against the USD, though with a series of downfalls, for years. Ethereum demonstrated an exponential growth pattern and grew from $15 to $371 in a matter of three and a half months. Fast-paced growth and speculative opportunities are not the only reasons why the financial community is paying close attention to cryptocurrencies. They are believed by some experts to change the world financial system forever.

Etherium rise and fall

It is not necessary to invest in expensive hardware worth thousands of US dollars to mine cryptocurrencies on your own or deal with overcomplicated online exchange points. When trading with IQ Option, the process of trading the cryptocurrency of your liking is as smooth as any other trading operation. The world’s most popular cryptocurrencies are now close at hand.

CFD stocks

CFD stocks trading will be available on IQ Option platform in October.

When trading CFDs, instead of buying a share in a company and becoming one of its owner, you forecast the future direction of the price action and capitalize on the difference between the current and the forthcoming prices. Choose from the world’s largest and most known company. Follow corporate and industry news to capitalize on CFD stocks using fundamental analysis or apply your knowledge of technical analysis to trade existing market patterns.

The New York Stock Exchange is the largest stock market in the world that trades a daily volume of $22.4 billion. The FX market can boast $5.3 trillion of a daily volume traded. Forex, however, is not only 200 times bigger than the world’s largest stock exchange, it is also extremely volatile. Exchange rates constantly fluctuate, creating numerous speculative opportunities for traders willing to face the risks of high volatility.

Risks and multiplier

The risks associated with CFD trading mostly lie in the sphere of using a multiplier. A multiplier is a truly double-edged sword. When you get the forecast wrong, the losses your account will incur will also magnify. This is the main risk of using any amount of borrowed capital and especially high multiplier ratios, e. g. 100:1 and 1000:1.

If you are not being deliberate enough you can incur heave losses in a relatively short period of time. When you trade with a multiplier and the trend starts moving in the wrong direction, you will start losing the money to cover the losses in borrowed capital. Volatility spikes can therefore eliminate your entire margin in no time.

Certain Forex dealers would offer multipliers as high as 3000:1. Not only it is risky, the strategies involving extremely high multiplier ratios have little to no chances of providing positive returns in the long run. Knowing the risks of margin trading is essential to successfully utilizing this tactic in the Forex market.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
In accordance with European Securities and Markets Authority’s (ESMA) requirements, binary and digital options trading is only available to clients categorized as professional clients.

GENERAL RISK WARNING

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
87% of retail investor accounts lose money when trading CFDs with this provider.
You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

What are the risks of CFD trading?

CFD trading can be lucrative, but there are many risks to watch out for.

Last updated: 28 February 2020

  • AvaTrade
  • City Index
  • easyMarkets
  • eToro
  • FP Markets
  • FXCM
  • GO Markets
  • IC Markets
  • IG
  • InstaForex
  • Pepperstone
  • Plus500
  • Saxo Capital Markets
  • TradeDirect365
  • Vantage FX

Get exclusive money‑saving offers and guides

Straight to your inbox

A Contract for Difference (CFD) is a highly leveraged, complex product which is ideally suited to very experienced traders and investors. CFDs can be highly lucrative and provide an opportunity to make a lot of money quickly, but you can also lose a lot of money just as quickly if you’re not experienced. This guide covers the risks involved with CFD trading.

Plus500 CFD Trading Offer

Finder exclusive offer: Open a new trading account with Plus500 and receive a welcome bonus of AU$110 when you deposit your first $370 and enter the code “Special200”. T&C’s apply.

Access more than 2000 financial instruments with a Plus500 trading account including share market CFDs, forex, indices and commodities. Pay no sign up fees, no ongoing subscription fees and no commission on trades.

What is CFD trading?

CFDs allow traders to speculate on the value movements of a large range of financial products and assets – anything from share prices and currency pairs to the price of gold or oil. CFD traders do not own the underlying asset nor are they trading the asset itself but are instead speculating on whether its value will increase or decrease. For more information on CFDs, check out our guide: What is a Contract for Difference (CFD)?

What are the risks of CFD trading?

CFDs can seem appealing as you have the potential to earn a lot of money quite quickly. This is because they are highly leveraged, so even though you only need to put forward a small margin of the complete trade value to initiate a trade, you can still benefit from 100% of potential gains. But there are many risks involved, which are detailed in this section.

CFDs are complex

CFDs are complex products so there’s room for misunderstanding and trading errors. While investing in shares is a strategy suited to both new or experienced investors, CFDs are best left to highly experienced traders.

You could lose more than your initial capital

If you put $50 into a pokie machine, the most you stand to lose is $50. However, with CFD trading you could lose more than you originally invested. Trading CFDs is more risky than traditional share trading as you’re trading with leverage. Traders are only required to put forward a small amount of the total trade value, often only 5%. However, if the trade goes in their favour, they are entitled to 100% of the profits. But the reverse is also true: traders are responsible for 100% of the losses too. Let’s look at the fictional example below, courtesy of ASIC’s Moneysmart website.

Imagine a trader buys 4000 CFDs at $5 per order, for a total of $20,000. The CFD has a margin of 5%, meaning the trader only pays $1000 to open the trade (ignoring possible commissions). The trader believes the price of the share will rise in value, so they go long on this trade. If the price of the underlying share the CFD is speculating on rises or falls in value, the table below shows possible gains and losses.

If the price of the share To You could gain
Rises by 20% $6.00 $3934.00
Rises by 10% $5.50 $1937.00
Rises by 5% $5.25 $938.50
If the price of the share To You could lose
Falls by 5% $4.75 $1058.50
Falls by 10% $4.50 $2057.00
Falls by 20% $4.00 $4054.00

If the margin was lower than 5% the risk becomes even greater. In addition to any losses, this table doesn’t take into account any potential commissions, fees or interest the trader may need to pay.

CFDs are contracts

When trading CFDs, you’re buying a contract between you and the CFD provider. The contract outlines your speculations about the value of the financial product or underlying asset and is a legally binding agreement. Unless you have some trading knowledge and the time and patience to digest the provisions of the contract, you could get stung by a hidden clause.

The CFD provider may not act in your best interest

Not all CFD providers will act in the best interests of clients. This is referred to as counterparty risk. For example, there may be a delay between when you place a CFD order and when the provider executes it. This might mean your order is executed at a price which is worse, potentially costing you big dollars. If your trade is making a loss, your CFD provider could close out your trade at a loss without consulting you. The opposite is also true: you could implement a stop-loss order to try to protect yourself from losses, but the CFD provider may not honour this and might keep your trade open even longer. Because of these factors, the success of a CFD trade doesn’t just rely on your ability to make correct speculations and assumptions on the value movements of assets, but it’s also dependant on the CFD provider you use.

Your money might be held with other traders’ money

Every CFD provider has their own terms and conditions, but your money is generally covered by the law against a CFD provider misusing your funds. Some CFD providers may pool your money into one account mixed with money from other investors. They are then permitted by law to withdraw some of this money in the form of an initial margin and also a further margin if they need to. If your CFD provider withdraws this money it’s no longer protected by the law as it’s no longer in a client account and therefore counted as client money. If your money is pooled with other investors there’s an additional risk if one client fails to pay the money they owe in the event they lose a trade. This could delay your payments as the pooled account will be in deficit.

CFDs can be affected by market conditions

Because you’re speculating on the price movements of financial assets, such as shares, your trade will be affected by broader market conditions. However, because CFDs are highly leveraged, even a tiny dip in the market can result in not-so-tiny losses. Trading CFDs could become even more risky if you’re trading during times of economic uncertainty, such as major political elections. However even if the market is stable, there are often unpredictable, seemingly random events that affect the price movements of various financial products, making it almost impossible to predict for even the most experienced traders.

CFDs can move quickly

This is called ‘gapping’ and refers to the idea that a CFD can move in price between, for example, $5.50 and $6.00 without stopping at any of the price points in between. Therefore, even if you’d planned to close a trade at $5.55, you might not get a choice. Because the prices move so quickly, this opens up traders to increased risk.

How to mitigate these risks when trading CFDs

CFDs are a high-risk strategy and this is reflected in the strong warnings regulatory bodies such as ASIC place on them. Most investment strategies have an element of risk, and it’s important to understand what they are and what you can do to mitigate these risks before you begin trading. Here’s some strategies to mitigate the risks of trading CFDs:

Do your research.

Like any investment, it’s important to do lots of research before you begin. The more you understand about the ins-and-outs of CFD trading and the risks involved, the better.

Select asset classes you have experience with.

It’s a good idea to trade CFDs with underlying assets you understand and have experience with. For example, if you have lots of experience with share trading and understand what factors affect share prices, you could consider trading shares CFDs to begin with.

Start small.

It can be tempting to go big when you first get started, but remember when trading with leverage if you have the potential to gain a lot, you also have the potential to lose a lot. Trading in small sizes to begin with is a good way to get comfortable trading with leverage. It also means that if your trade doesn’t go as planned, you’ll only lose a small amount.

Open a free demo account.

Before committing your own money to a trade, why not take advantage of one of the free demo accounts offered by a number of CFD brokers on the market? IG Markets, Saxo Capital Markets and Pepperstone (to name a few) all offer demo accounts that allow you to practice executing trades in a simulated environment, providing you with an opportunity to test strategies and learn the mechanics of trading without risking any of your own capital. They even provide you with a small stipend of virtual funds to practice with.

Use stops and limits.

Tools such as stop losses and limit orders are a great way to minimise your risk, as they effectively allow you to cap your losses at a certain amount. These tools are a good way to protect traders against sudden or unexpected market movements, and are offered by most CFD trading providers.

Understand what you can afford to lose.

As CFDs are highly leveraged products, you can lose a lot more than your initial capital used to place the trade. It’s important to understand how much money you can comfortably afford to lose, so in the event that your trade doesn’t go well, you’re not losing more than you can afford. If you have done plenty of research and have extensive trading experience, you can compare CFD providers in our table below. If you want to learn more about CFDs, read our guide: What are CFDs?

Compare CFD providers

Isaiah Peralta

Isaiah Peralta is the head of distributed support at Finder. He previously worked as a Finder publisher across a variety of topics, including Shopping deals, broadband, credit cards and travel money.

Where to buy blue light glasses online

This is where you can buy blue light glasses and have them delivered straight to your door.

Where to buy rice cookers online in Australia

Cook perfect rice every time with rice cookers available online from these retail outlets in Australia.

Cryptocurrency trading shrinking relative to other assets

What are the traders doing amidst coronavirus – which asset classes are in and which are out?

Crypto Fire Alliance completes fundraising for Australian bushfires

Bushfire season has officially ended and with it the Crypto Fire Alliance fundraising effort.

Binance snags CoinMarketCap in major acquisition

It’s believed to be one of the largest acquisitions in the cryptocurrency space to date.

Ask an Expert

Level 10, 99 York St, Sydney , NSW , Australia 2000

  • About Us
  • Careers
  • Media Room
  • Contact Us
  • Partner with Us
  • How We Make Money
  • Terms of Use
  • Privacy & Cookies Policy
  • Editorial Guidelines
  • Sitemap
  • © 2020 finder.com.au
How likely would you be to recommend finder to a friend or colleague?

Thank you for your feedback.

Our goal is to create the best possible product, and your thoughts, ideas and suggestions play a major role in helping us identify opportunities to improve.

Important information about this website

finder.com.au is one of Australia’s leading comparison websites. We compare from a wide set of banks, insurers and product issuers. We value our editorial independence and follow editorial guidelines.

finder.com.au has access to track details from the product issuers listed on our sites. Although we provide information on the products offered by a wide range of issuers, we don’t cover every available product or service.

Please note that the information published on our site should not be construed as personal advice and does not consider your personal needs and circumstances. While our site will provide you with factual information and general advice to help you make better decisions, it isn’t a substitute for professional advice. You should consider whether the products or services featured on our site are appropriate for your needs. If you’re unsure about anything, seek professional advice before you apply for any product or commit to any plan.

Products marked as ‘Promoted’ or ‘Advertisement’ are prominently displayed either as a result of a commercial advertising arrangement or to highlight a particular product, provider or feature. Finder may receive remuneration from the Provider if you click on the related link, purchase or enquire about the product. Finder’s decision to show a ‘promoted’ product is neither a recommendation that the product is appropriate for you nor an indication that the product is the best in its category. We encourage you to use the tools and information we provide to compare your options.

Where our site links to particular products or displays ‘Go to site’ buttons, we may receive a commission, referral fee or payment when you click on those buttons or apply for a product. You can learn more about how we make money here.

When products are grouped in a table or list, the order in which they are initially sorted may be influenced by a range of factors including price, fees and discounts; commercial partnerships; product features; and brand popularity. We provide tools so you can sort and filter these lists to highlight features that matter to you.

We try to take an open and transparent approach and provide a broad-based comparison service. However, you should be aware that while we are an independently owned service, our comparison service does not include all providers or all products available in the market.

Some product issuers may provide products or offer services through multiple brands, associated companies or different labelling arrangements. This can make it difficult for consumers to compare alternatives or identify the companies behind the products. However, we aim to provide information to enable consumers to understand these issues.

Providing or obtaining an estimated insurance quote through us does not guarantee you can get the insurance. Acceptance by insurance companies is based on things like occupation, health and lifestyle. By providing you with the ability to apply for a credit card or loan, we are not guaranteeing that your application will be approved. Your application for credit products is subject to the Provider’s terms and conditions as well as their application and lending criteria.

Please read our website terms of use and privacy policy for more information about our services and our approach to privacy.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Broker 2020!
    Perfect For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-up Bonus Now!

  • Binomo
    Binomo

    Good Broker For Experienced Traders!

Like this post? Please share to your friends:
How To Do Binary Options Trading?
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: