A Beginner’s Guide to CFD Trading

There has been a paradigm shift and people now are more open to trading. The fear of losing it all has gone. People do not just invest in mutual funds as ‘trading’ but also pick individual assets like currencies, cryptocurrencies, oil, gold, and stocks.

The core difference between how two traders function could be based on the market and the asset. Trading is often spoken as a very different thing from investment. If you choose a profitable asset with the possibility of making stable profits you end up with a strong investment.

If you pick a highly volatile asset and spend enough time to make large profits in a short duration, you end up with a reliable source of income. The size of profits and consistency can determine whether it is your primary or secondary income. Therefore trading can mean different things to different traders all over the world.

When we talk about trading, the common notion is that you buy something and then sell it at a higher price. What you buy and sell is the trading instrument or the asset which could be commodities, equities or currencies.

There is one other dimension to trading that we do not often cover and that is CFD or contract for difference. This is a method where you trade based on price changes without buying or selling anything. There is no ownership. You only have profits or losses. Bitcoin trading with investment robots like the Bitcoin Trader has been extremely popular lately..

What Exactly is CFD?

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CFD stands for contract for difference. It is a form of derivative trading. Therefore trader orders are made here on the value of the asset and not the asset itself. There is no ownership involved and therefore the taxes attached with ownership can be given up.

There is an ample amount of perks that you get to enjoy when you choose CFD. This is one reason why this derivative trading strategy is becoming very popular.

How Does CFD Trading Work & How is it Different from Conventional Trading?

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When you are trading the traditional way you buy assets. This means that you would have to pay the value of the asset that you purchase. Therefore depending on the price of the budget and the quantity your deposit amount varies.

It can often be a large value. In the case of CFDs, you are only trading the derivatives or price changes. You would not have to pay the whole value of the assets being traded. CFDs can be chosen even when you have a small budget.

When you choose to trade in CFDs there is a buyer and a seller. CFD is a contract that is directly signed between the buyer and the seller. The brokers or brokerage companies that allow CFD trading would be purchasing the assets for CFDs.

The broker would pay the price of the asset based on the chosen quantity and would thus bear the ownership. It would be the owner of the assets that pays stamp duty and other taxes on ownership.

As a CFD trader, you would get into a contract with the owner of these tradeable assets. The contract would define two things among the other clauses – the direction of price movement and a time period. The contract lapses at the end of the stipulated time period. If the price of the asset in question moves in the same direction as you had predicted then you would earn your profits.

The profit here would be the actual price change that happens. If the price happens to move in the opposite direction then you would have to pay the amount that equals the price change. Therefore you only earn or lose based on the actual price changes.

Benefits of CFD Trading

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  • One of the major benefits that attract people into CFD trading is the flexible deposit size. Anyone with a small budget would be able to try their hands at CFD trading.
  • As you would not pay the whole price of the assets involved you would be able to trade even the most expensive assets like gold. Therefore for traders who like to work with different asset classes without spending a fortune, CFD trading is an easy choice. This helps to add diversity in your portfolio the easy way.
  • There is a significant difference in the amount paid as taxes when you trade CFDs. Ownership tax and stamp paper charges are not applicable to CFD trades. You would only have to take care of the capital gains tax for the profits you make.
  • The predictability involved in CFDs is another huge benefit. Here you would have a fair picture of the kind of profit or loss you are likely to incur. Therefore you can plan your budget conveniently.
  • Liquidity is also a great factor while choosing CFDs. You would be able to trade without thinking about the ease of buying or ease of selling assets. Therefore you do not have to worry about being stuck with some assets if you cannot sell them. If liquidity is your prime concern then CFDs work like a charm. Here you either earn money for a prediction or lose money. It is as simple as that. There is no question of how and where to sell the assets. There is no question of what happens if you cannot actually monetize the asset.
  • The transaction costs on CFD trades are much lower than those on actual trades.
  • CFDs are convenient options that people use for hedging even during market downtrends.
  • Market crashes might make trading in general quite complicated. But if you are trading CFDs you would be able to make profits even from a trailing market. So even when the prices of various assets are dropping continuously you would be able to take your profits. You must hear the terms going ‘long’ and ‘short’ in CFD trading. Going long means that you pick assets which are likely to show an upward price trend. You make profits from the increasing value of the asset. Short selling is applicable to the falling markets. This is where you choose assets that show a downward price movement.
  • With trading the normal way you would have to choose a specific market and an asset class. You would not be able to trade outside of it even when you have a wealthy collection of assets. But with CFDs, you can explore various markets like forex, cryptocurrencies, commodities, stocks and more.

It Has its Limitations!

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While there are plenty of perks to trading CFDs, but it does have its downsides.

  • When you buy a stock you can retain the stock without selling it for however long you want. CFDs are contracts with an expiry date. If you wish to extend the position or wait till things actually move the way you predicted you would be paying extra costs.
  • When you own assets like stocks you get to enjoy the ownership privileges. The dividends that most firms credit on the basis of the number of stocks owned is a good example. Such perks are not available to those who trade CFDs. The only way to make money here is to predict the price change correctly.
  • There is a chance of losing more money that you invest in the case of CFDs. Unless you plan well the possibility of making a huge loss is more in the case of CFD trading. This is one of the strongest limitations of CFDs that creates skepticism in most traders. But it can be averted if you have strong money management skills and if you understand the market well.
  • CFDs, like the other assets, can be traded either directly or with the use of bots. These can help automate your investment process. CFD trading bots also offer a diverse mix of assets for your investment. You would, therefore, be able to try different asset classes in the market based on their performance at any given time.

Would You Try Your Hands at CFD Trading?

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After knowing a few basics about CFDs are you ready to try them? If you do plan to use CFD trading in your investment portfolio, make sure that you choose reputable platforms with CFD experience. Know when to go short and when to go long.

Set realistic goals and have a plan to keep your losses within an affordable level. There are some CFD trades where you would also gain direct market access and round the clock trading support. These are great if you are a day trader.

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