subject: Cfd Trading - Benefits And Risks Involved [print this page] What Is CFD Trading? What Is CFD Trading?
When you trade on the basis of a Contract for Difference or CFD, it is known as CFD trading. CFDs are flexible trading agreements between a buyer and a seller that allows the seller to only pay the difference in the value of a particular share between the current value and its value at the time at which the contract was made. They help the traders as they can take advantage of the market going up and down without actually having to buy the shares. This means that you can trade in the price of a stock without actually having to buy or sell that particular stock. You only need to pay a margin or a deposit which is much less than the actual cost of the particular share.
Advantages Of Cfd Trading
This kind of trading is similar to normal trading with the only difference being that instead of buying a specific share you deal at its cash price and pay a commission. This means you can trade up to 20 times your initial capital. Another benefit of CFD trading is that as you are not making any purchase you don't have to pay any stamp duty.
One can use CFDs to deal in a cross section of market and trade an extremely wide range of financial products. You need only one CFD account to deal in Wall Street and the exchange rate of the dollar against the euro.
Risks Involved
As mentioned before, CFD trading is done on a margin which means a user has to deposit only a small sum of money used to hold large positions. This is an advantage as well as a disadvantage as this leveraging effect increases the risk significantly. You can lose much more than this deposit if the market moves against you.
There is also the risk of liquidation of positions if the market moves suddenly. The user is required to maintain the level of margin he has deposited and if the market rises then he has to pay additional sum to maintain the balance. In case the market shoots up suddenly, then the user would only get a short notice to pay otherwise the CFD provider has the right to close or liquidate your position.
Another risk involved is the counterparty risk factor which is associated with the financial stability of the contract. If the counterparty fails to meet their financial obligations, the contract would lose all its value and would be worthless. So, even if the product is doing well but the counterparty is not able to keep up its side of the financial position, then you would incur a loss.
Techniques To Manage Cfd Risks
You need to understand the market before investing in a CFD. Check for sudden movements in the market that can lead to losses. Some markets such as equities have the tendency to jump suddenly which could ultimately lead to a loss. Secondly, you need to understand and monitor your account so that you can counteract if a sudden jump happens in the market.
However, the most effective way to manage CFD risks is to use guaranteed stops which put a fixed limit on your potential loss without putting a stop on your profits.
While CFD trading has many advantages, it involves great risks too. When you decide to enter into this aspect of trading it is advisable to do a little bit of research, especially of the market so as to avoid losses.
by: Jonathan Ramos
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