Pros and Cons of Trading CFDs
CFDs also known as “Contract for Difference” is referred to as the contract between the buyer and the seller that sets out that the buyer must pay the seller the difference between the current value of an asset and its value at the time when the contract was made. This allows traders to speculate on the asset’s price movement and make profits without actually owning the underlying asset.
How do CFDs work?
In CFD trading, there is no exchange of physical goods but traders only bet on the direction of the price movement i.e. whether the price will go up or down. If a trader believes that the price of an asset will increase in the future, he takes a buy position and when the price is expected to fall, the trader sells his holding. The difference between the buy and sell price decides whether a trader has earned a profit or incurred a loss.
Pros of using CFDs:
1. High leverage: CFD brokers offer high leverage which allow traders to open larger positions outlying a huge capital. Moreover, the margin requirements in CFD trading are lower than the margin required in traditional trading.
2. Profit potential in both bear and bull markets: CFD trading gives traders an opportunity to take both long and short positions helping them to make profits in both rising and falling markets.
3. Lower trading costs: The trading costs for CFDs is comparatively very less than the traditional trading. Brokers mainly make money through spreads and commissions which also are very reasonable with some low cost brokers.
4. No expiration date: CFDs do not have any expiration date which means you can buy and sell them anytime without any restrictions.
5. Ability to trade small lots: Many CFD brokers offer flexible lot sizes for trading, such as micro lots, mini lots and standard lots. This helps traders in limiting the risks by trading small position sizes.
Cons of using CFDs:
1. Leverage is a double edged sword- The same high leverage that can amplify your profits can also work against you and magnify your losses.
2. Risk of margin loss: The market is extremely volatile and when you enter the trade undercapitalised and overleveraged, even the smallest price movement can wipe out your entire account and sometimes, it may even result in negative account balance. Therefore, traders should always seek out brokers who offer negative balance protection, such as:
There are many well-defined lucrative advantages of trading CFDs. But as we know now that it also comes with risks, one should be very careful and always follow sound risk management techniques.
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