Having appeared in the not-so-distant 1990, contracts for differences quickly gained popularity among investors all over the world, and today they are in high demand not only among beginners, but also among professionals. There are many reasons, but to understand them you need to understand what this financial instrument is and how to work with it. We offer you a small excursus into the field of trading the most speculative product of our time.
Getting to know CFD for the first time
Many traders have already tried this financial instrument and appreciated its ample opportunities, but there are speculators who do not dare to try this experiment. It's hard to say what is the reason for such doubts. Maybe it's fear of trying something new, or maybe excessive caution, or maybe just the lack of reliable information. In any case, Familiarizing yourself with the principles of CFD trading is necessary for everyone. Who knows, maybe this tool will be your key to profitable trades.
Contract for difference (CFD - contract for difference) - is a marginal product that allows you to profit from a rise or fall in the price of the underlying asset without owning the asset itself. All instruments quoted by the broker (stocks, indices, commodities) can be the underlying asset, futures etc.) The amount of profit is calculated as the difference between the opening and closing price of the position minus commissions. Due to its numerous advantages, the CFD contract has gained recognition throughout the world and has become very popular among a large number of traders.
7 reasons to start trading CFDs
The use of leverage
One of the features of the contract for difference is that when trading it provides leveragewhich allows the trader to make transactions with sums well in excess of the size of his security deposit. As a rule, this amount is about 5-10% of the contract value. To make it clearer, here is an example. If the leverage is 1:10, then in order to conclude a contract to buy shares for $30,000, the investor will only need to make a deposit of $3,000. Moreover, the profit from changes in the price of the underlying asset (as well as the loss) will be multiplied by 10 in accordance with the amount of leverage.
2. Ability to open both long and short positions
This important advantage allows the trader to earn not only on the increase in the value of the asset, but also on the decrease. Transactions are settled much faster than when trading a physical asset.
3. Receiving dividends on CFD shares
If you hold a long CFD position on the actionon which the dividend is paid, you get a dividend payoutas if you yourself were the holder of that stock. However, in the case of a short position, the dividend amount is deducted from your account.
4. Minimum interest deductions
The trader pays a certain fee (depository service, stamp duty, etc.) for the execution of an exchange transaction. In the case of CFD this amount is minimal and is 0.1-0.5% of the contract value, and sometimes not at all. This feature (coupled with the lack of the need to physically possess the underlying asset) makes this investment instrument an ideal option for short-term investors.
5. Ability to hedge risks
If you own stocks or commodity futures and do not want to sell them even if their value declines, you can open a short CFD position on these assets. Thus, losses from initial positions will be compensated for profit on contracts.
6. Compressed spreads
When trading CFDs obtaining market spreads occurs without any expansion. This allows you to trade at the same prices at which stock traders trade.
7. The streaming nature of quotations
The buy and sell price changes every second in automatic mode. The computer makes the quoting, and the order triggering time is 0.01 seconds. You just press a key and you know at what price a trade is made.
A word about the shortcomings
Speaking about the advantages of CFD, it is impossible not to mention one disadvantage.
As a marginal product, CFDs carry certain risks. Using this financial instrument, the trader must understand that the provision of large leverage can lead to an increase not only in the amount of income, but also in losses. It is very important to realize the high degree of risk and adequately assess your financial situation.
How to choose a reliable CFD broker?
For traders who intend to trade CFDs, one of the main things to pay attention to is the choice of a reliable broker. When trading this financial instrument the contract is with the brokerThe trader does not own the underlying asset directly. Therefore, if a broker is unreliable, his clients can lose their investments.
Today, services of direct access to the exchange are offered by many brokers and investment companies. The easiest way to choose a reliable broker is to refer to the list of the leading operators in the market according to the versions of various representative publications. However, do not limit yourself to this action, because not always "popular" means "the best. Try to consider all possible candidates. Carefully study their background, legal data and the conditions under which they work, and only then make your decision.
The legal side
Speaking of the legal side, first and foremost we mean availability of necessary licenses, regulation by state authorities, as well as financial guarantees from associations, foundations and governments. A licensed broker is absolutely transparent. He does not hide his statutory documents and financial statements. And the regulatory body fully controls its activities.
By far the most valuable licenses are those issued by the following international organizations:
- FSA - Office of Financial Regulation and Supervision;
- NFA - National Futures Association;
- CFTC - U.S. Commodity Futures Trading Commission.
About a dozen brokers in Russia and the CIS countries have such licenses.
Additional factors to consider when choosing a broker are how long it lasts, availability of liability insurance system to the clientas well as a well-functioning system of internal risk management. In addition, a reliable broker must be respectable and have representative offices all over the country (if it is a Russian broker) or all over the world (if foreign).
The financial side
As for the financial side, when trading CFDs, you should pay attention to such factors as:
- minimum commission requirements;
- minimum security deposit;
- guaranteed execution of pending orders;
- a wide variety of tools.
It is extremely important that the broker provide a comfortable and modern platformThis allows to avoid "spreading of funds", i.e. the situation when there is not enough money on one of the accounts to maintain open positions. This allows you to avoid the "spreading" of funds and the so-called margin deficit - a situation where there is not enough money on one of the accounts to maintain open positions.
In addition, if we are talking about a foreign broker, an important role is also played by such advantages as: round the clock Russian language support, a personal manager и high-quality service European level.
Today, CFDs are common all over the world. They provide an inexpensive way to trade a large number of financial products without having to buy and sell them. However, this instrument should not be regarded as a complete substitute for the stock market. The risk of losing money when trading CFDs is no less than when trading exchange-traded instruments, especially if the market moves against the trader's position with a small deposit.
However, the exact opposite approach is also wrong. CFD is not a scam, not a fraudulent scheme of crafty brokers. With the correct prediction of changes in the prices of underlying assets, this tool can become a real opportunity for good earnings.
Article prepared by Artem Azizov