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With time, it seems more and more modern traders shift towards CFDs from traditional trading or start using both trading methods simultaneously. The reason lies in the different nature of the two. While fundamentally both are trading instruments, they vary quite a bit once we start getting into their nuances.
If you’ve been wondering, “Why should I trade CFDs?” you’ll know exactly why in this blog post. Let’s uncover everything you need to know about this form of trading.
What is CFD Trading?
CFD (Contract for Difference) is a trading instrument in which you simply speculate on the price of assets like stock, crypto, and commodities, instead of having to own them. Essentially, you’re not buying any of these financial assets but merely entering into a contract with a broker to trade on the difference between the opening and closing price of the financial assets.
Let’s say you believe Tesla’s stock is going to rise from $200 to $220. You buy a CFD at $200, and the price does indeed climb up. Now, since your prediction was correct, you make a profit on the $20 difference. On the flip side, however, if you believe the price of, say, gold will drop, you can sell a CFD at $2,000 per ounce. If the price falls to $1,950, you profit from that $50 decline.
One of the biggest differentiators and reasons why traders choose CFDs over traditional trading is the concept of leverage. Instead of having to pay the full price of an asset (and owning it, as is the case with traditional trading), you only need a fraction of the total value to open a trade. This means you can control a larger position with less capital, turning this entire thing into a high-risk, high-reward situation.
How CFD Trading Works
To understand how CFD trading works, let’s pit it against traditional trading and see how they differ.
In traditional stock trading, for a trader to trade, they need to buy at least a single share in full and own it. They can profit from selling it at a higher value than when they purchased it or potentially earn dividends.
Now, no such concept of dividends exists in CFD trading, and here’s a major difference between CFD trading and traditional trading. There’s no ownership involved. With CFDs, the underlying assets whose price movements you’re betting on aren’t actually owned by you. This opens up a whole new dimension as you don’t have to:
- Make a major investment initially to start trading
- Pay stamp duty (since there is no ownership involved)
- Wait for the market to be bullish to gain a profit
By short-selling (a concept that does exist within traditional trading but is much more complex to perform there), you can earn a profit even from falling prices.
This low barrier to entry can be largely credited to the concept of leverage and margin. As mentioned before, traditional investing requires an individual to pay in full for an asset, and only then, once they own it, can they trade it.
CFDs allow you to trade with a fraction of the total trade value, meaning that with a much smaller deposit, a trader is able to control a much larger position. A 10:1 leverage means a $1,000 deposit lets you trade $10,000 worth of assets. While this can boost profits, it also increases risk since losses are based on the full position size.
The small percentage of the amount that you must put in to initiate a trade is called a margin. If the margin requirement is 5%, you only need $50 to control a $1,000 position. The concept of spreads (consider it like a fee or a commission) exists within CFD trading, and it is the difference between the buy (ask) and sell (bid) price. A tighter spread is better since it means less cost to enter a trade.
Key CFD Markets
Many markets have the option for CFD trading, but the major ones include:
- Stocks: Trade shares of major companies without owning them.
- Forex: Speculate on currency pairs like EUR/USD.
- Commodities: Trade gold, oil, and other raw materials.
- Indices: Trade baskets of stocks (e.g., S&P 500, FTSE 100) instead of individual companies.
- Cryptocurrency: Some brokers offer CFDs on Bitcoin, Ethereum, and other digital assets.
Also, be sure to learn the difference between CFD broker vs Crypto exchange.
5 Reasons to Trade CFDs Today
CFD markets are open 24/5, and if you’re looking for an alternative to traditional trading that is faster-paced, right now is as good a time as any. If you’re unsure, here are five reasons why you should try CFD trading:
1. Trade with Leverage (Without Breaking the Bank)
The biggest issue with traditional trading is that to gain any substantial profit outside of those lottery-like sheer luck scenarios, you must invest a considerable amount as well. This barrier to entry often discourages people who were interested in finance trading.
However, this issue does not exist within CFDs, as the concept of leverage exists, allowing you to open large trades with a smaller deposit. Certain brokers, like XBTFX, even offer up to a 500:1 ratio. Keep in mind that the higher the reward, the higher the risk.
2. Go Global: Access 10,000+ Markets in Seconds
We mentioned the key markets above that CFD trading gives you exposure to, such as stocks, forex, and crypto. However, these are the major markets. You can access over 10,000+ markets from a single account, 24/5.
3. Profit in Bull or Bear Markets
Yet another drawback of traditional investing is the sheer amount of waiting you must do at times. Profiting in bear markets is possible, but it is extremely complex and not viable for every level of trader.
CFDs make short-selling easy, giving you the opportunity to benefit from falling markets and stay active, no matter which direction the market is going.
4. Zero Ownership, Zero Hassle
Nobody likes paperwork or ownership taxes like stamp duties. With CFDs, since there’s no direct ownership of any asset, there’s no paperwork, dividend concerns, or custody fees. Simply speculate on price movements and potentially gain profits.
5. Hedge Your Existing Portfolio
If you already hold stocks or other investments, CFDs can act as a hedge against losses. For example, if you own Tesla shares but expect a short-term dip, you can short-sell Tesla CFDs to offset potential losses. It’s tricky because the market is volatile and moves quickly, but it can be done.
Risks of CFD Trading
While CFD trading has many perks, it’s best to look at it objectively and understand that there are always risks associated with any form of trading, and CFD trading is no different. Here are the three major risks that you must learn to work around:
- Leverage Cuts Both Ways: Leverage is just like a coin because it has two sides. It can massively amplify your gains with a small deposit, but it also increases exposure to losses. A small price movement against your position can sometimes even exceed your initial deposit. For example, with 10:1 leverage, a 10% price drop can wipe out your entire investment.
- Overnight Fees Can Add Up: Unlike traditional trading, holding stocks and shares long-term is not common in CFD trading. You can, on paper, hold them indefinitely, but the overnight financing fees can add up. If you keep a CFD trade open past the daily market close, the broker charges a small interest-like fee. These fees start to eat into whatever profits you might be intending to earn by holding, accumulating over time and reducing your overall profitability even more.
- No Shareholder Rights: Since there’s no ownership, there are no shareholder rights involved with CFDs. Traders receive no shareholder benefits like voting rights or dividend payouts. This makes CFDs better suited for modern traders interested in short-term trading rather than long-term investments.
How Pros Minimize CFD Risks
Risk is a part of trading. The art of trading requires strategic planning and proper risk management, as risks are always present where there is an opportunity for profit. CFDs have been around since the 1990s, so with over three decades of experience, there are proven strategies to minimize the risks. Here are three of the best strategies:
1. Use Stop Losses Religiously
Key word: religiously. The value of stop losses cannot be overemphasized. Stop losses refer to an order that automatically closes a trade at a predefined price to prevent excessive losses. Since leveraged trading paired with a fast-moving market can swing the price in the wrong direction rapidly, it’s an essential aspect of any CFD trader’s risk management strategy.
2. Avoid Over-Leveraging
High leverage is extremely tempting, but it’s equally dangerous. The potential for a high payout brings its friend, the potential for massive losses, along with it. To tackle this, it’s best to use lower leverage ratios despite being offered high ratios and risk only a fraction of their capital per trade to avoid devastating losses.
3. Stick to Liquid Markets
Highly liquid assets refer to major forex pairs (EUR/USD), large-cap stocks (Apple, Tesla), and major indices (S&P 500, FTSE 100) that are easy to buy and sell without the price jumping around too much. These markets have a ton of buyers and sellers, so you can enter and exit trades smoothly.
While trading something with low liquidity, like a small, unknown stock, can result in gains, it can also make it difficult to get in or out. There just aren’t many people buying or selling this specific asset. That means bigger price swings and wider spreads, making it harder to enter and exit trades without losing money on the spread.
Bottom line: Trade popular markets so you don’t get stuck with bad prices.
How XBTFX Gives You an Edge in CFD Trading
CFD trading is far from a get-rich-quick scheme. It involves careful planning and execution, something that may be delayed without access to a broker that accommodates your style and preferences.
Keeping that in mind, we introduced XBTFX to support different trading approaches. We’re an award-winning cryptocurrency-based forex and CFD broker, offering three types of live trading accounts: Standard, ECN, and Islamic.
You get various advantages that align with what serious traders seek, such as:
- Access to 200+ trading instruments
- Access to professional strategies so that experienced traders can earn commissions by sharing their successful CFD trading strategies with the community
- Leverage of up to 500:1
- Tight spreads, low fees, and transparent costs
- Trade on MetaTrader 4 & 5 Along With cTrader. These industry-standard platforms come with advanced charting tools and automated trading options
- Reliable 24/7 customer support + an active community for quick updates and discussions
- Risk management tools, such as stop-loss, negative balance protection, and multi-account options
Join 50,000 traders who trust us for quick, safe, and easy CFD trading, which is precisely what we’ve built XBTFX for. Create an account and get started right away.
Closing Thoughts
If you’re a trader whose style is to stay active regardless of market conditions, CFD trading is an excellent alternative to traditional trading. Pair that up with an outstanding broker and you’ve got yourself the perfect headstart into CFD trading. However, it’s important to always use proper risk management. Follow the golden rule of trading: Trade only what you can afford to lose, and you’ll trade with confidence, not fear.
FAQs
What is an advantage of trading CFDs?
There are several advantages of CFD trading, but the biggest one is arguably the concept of leverage, which allows you to control a much larger position with a fraction of the capital investment. This means you can make major profits from small investments. Also, CFDs make short selling easy, meaning no matter which direction the market is moving, you can make a profit by opting to go long (buy) or short (sell).
Why trade CFDs instead of stocks?
Both trading options are viable, but modern traders want flexibility and a fast-moving market, which stocks simply lack. Besides, to trade stocks, you must fully own at least one share. With CFDs, you don’t need to own the shares, and you can trade on price movements without dealing with things like stock ownership or dividends.
What is the benefit of CFD trading?
Benefits of CFD trading include access to 10K+ markets, 24/5 availability, lower costs, and a lower barrier to entry. Another advantage, which may or may not apply depending on your location, is the potential exemption from stamp duties, as there is no ownership involved.
Do professional traders use CFDs?
Absolutely! Many professional traders either use CFDs primarily or as part of their broader strategy. CFD trading is fast-paced, and whether a trader prefers that or not is up to personal preference. Generally, pros use CFDs to hedge portfolios, take advantage of short-term price movements, or gain exposure to markets without tying up too much capital. However, they manage risks carefully by using stop-loss orders and avoiding excessive leverage.
