What is CFD Trading?
What is CFD Trading?
What is CFD Trading?A CFD is a financial agreement between two trading partners to swap the difference between the opening and closing value of a contract. They can be traded without actual ownership of the underlying financial instrument in the market in which you are trading. In other words, it is a financial derivative.
Two of the key features and attractions of a CFD, for many investors, is the ability to use them to go short or long and to use leverage. Going short is selling against a backdrop of falling prices in the market. Thus, you can potentially profit whether prices are going up or going down. A CFD is traded using leverage; in other words traders typically pay a deposit or percentage of the total trade value.
As your position in the market is greater than your invested sum, you can potentially stand to profit more than you would without using leverage. It is important to be aware that leverage can also work against you, because losses are also potentially magnified by the use of leverage.
CFDs relate to, but do not entail, ownership of the underlying financial instruments in the market you are trading in. As a result, CFD traders do not have to pay stamp duty in the UK.*
Potential Risks of Trading CFDs
The use of leverage can be potentially risky, because both profits and losses can be magnified beyond the value of your initial deposit. If not monitored or stemmed at a manageable level, the falling value of your trades can result in serious losses.
CFDs, however, can be traded using risk management tools. Whether or not you think the market will fall or rise in value, you can start your trade with a guaranteed stop loss order. A guaranteed stop loss order acts as a safety net; it will stop your potential losses at a level predefined by you and beyond which you are not comfortable trading.
This means that you can calculate, in advance, the level of your losses at a point in the market. Whichever level you decide is a good place to terminate your position can be regulated using a guaranteed stop loss order.
As it is a financial derivatives product, which means you do not actually own the underlying financial instrument, you can use CFDs to trade a number of different markets. Some of the most common are the FTSE 100, the Dow, gold and crude oil.
There is a range of CFD trading companies like IG Markets however note that opening in account isn't guaranteed. All applications are subject to terms and conditions.
CFD trading does carry a high degree of risk to your funds and can result in you losing more than your stake. It might not be appropriate for all investors. Before you start trading, make sure that you fully appreciate the risks that are involved. Only trade CFDs with capital that you can afford to lose. Where required seek independent financial advice.
* Tax law is subject to change or may differ if you pay tax in a jurisdiction other than the UK.
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