What is a CFD?
A CFD, or Contract for Difference, is a derivative product that enables you to profit from price moves in the market, without having to own the stock you are trading. A CFD is effectively an agreement between two parties to exchange the difference between an opening and closing price for any particular stock. As a CFD is a leveraged product, you can trade by just paying a small part of the contract’s value, increasing your return.
A key feature of CFD trading online is the option to both go long and go short on a stock. If you think a company price or a market will rise, you can buy, and if you’re expecting a fall, you have the option to sell. This makes online CFD trading a more flexible alternative to traditional trading on market moves as you can profit whether the market falls or rises.
Online CFD trading gives you an additional hedging option, should your existing stock portfolio start to decline in value, enabling you to quickly offset any loss in the value of the stocks you hold, without having to purchase new stock. As a result, many investors employ online CFD trading as a viable short-term hedging option.
Using CFDs can also be a tax efficient way of trading, because you may be able to use losses incurred in CFD trading to offset against any Capital Gains Tax liabilities. And, as CFDs are a derivative, you don’t hold the stock you are trading, which means there is no need to pay stamp duty in the UK, which could save you 0.5% of the value of each trade.
CFD trading online can be quicker and easier than buying and selling stocks, which is important when market prices are moving quickly. It is also not dependent on the underlying market being open. Most online trading platforms will allow you to carry out CFD trading 24 hours a day, 7 days a week, making it a modern, convenient way to trade.
Online CFD trading is a form of leveraged trading. That means you only have to pay a fraction of the overall trade value, known as margin, when you take a position, rather than paying for the full amount. With many trading platforms and brokers your margin could be as low as 0.5%, so your initial outlay is significantly less than if you were buying stocks.
Because your full trade exposure is therefore many times greater then the initial cost of opening the position, your return on your investment is magnified, which is the great advantage of leveraged trading. The downside, of course, is that your losses will also be magnified if the market moves in a way you weren’t expecting, and your overall loss could end up being substantial. It is important to be fully aware of the risks when trading CFDs online, but good trading platforms will offer a range of tools to limit your exposure.