Is CFD Trading worth it?
WHAT IS (CFD) CONTRACT FOR DIFFERENCE?
A contract for difference (CFD) is referred to as the contract between two traders, buyers and sellers. The contract states that the buyer will pay the difference between the contract price and the present price. CFDs give traders the privilege to make income from price trends without acquiring the underlying trade. The price of the underlying trade does not affect the price of a CFD contract. The price of CFDs is influenced by the change in the exit and entry of the trade. Many traders wonder if CFD is worth it because they don’t know much about it. This article will help set those worries to rest.
This type of contract does not include stocks, commodities, futures, or Forex exchange. It is the contract stated between the trader and the broker. Trading with CFDs comes with a lot of advantages that have boosted its popularity.
HOW CFDS WORK
As stated earlier, CFD is the contract between a trader and a broker. The contract states that the buyer pays the difference in the price of a financial asset (Futures or options) from the opening of the trade to the closing.
The contract for difference is an advanced trading method mainly used by professional traders. Physical goods and securities are not delivered with this type of trading method. A CFD trader doesn’t acquire any asset but instead receives profit from the price difference of the asset. For instance, rather than purchasing gold, the buyer can bet on if the value of gold will increase or reduce.
Practically, traders use CFD to bet if the price of an underlying asset will fall or rise. Traders can bet on whichever price trend, it could bullish or bearish.
CFD BULLISH TREND
If a trader speculates that the price of an underlying asset will increase over time and the price increases over time. The trader will place his hold for sale. The price difference between the buy price and the ask price is the trader’s gain. The profit is given to the trader through the trader’s broker.
CFD BEARISH TREND
If the trader speculates that the price of the asset will reduce, he/she can place a sell position. The trade is only closed when the trader buys an offsetting trade. The price variation of the loss is paid to the trader.
COUNTRIES THAT ALLOW CFD TRADING
Some countries do not allow CFD trading. Countries like the United States do not allow CFD trading. But there are other countries without CFD trading restrictions. Countries like the United Kingdom, Germany, Singapore, New Zealand, South Africa, Italy, Nigeria, Denmark, Norway, Thailand, Belgium, Netherlands, Sweden, Hong Kong, France, Canada, and Spain.
In Australia, CFD contracts are allowed. But in recent times, The Australian Securities and Investment Commission (ASIC) has issued a few changes concerning the dispersion of CFDs to traders. The Australian Securities and Investment Commission’s mission is to enhance trader’s security by decreasing accessible CFD leverage to traders. They also plan to curtail CFD product features and exchange procedures that increase traders. CFD loses. ASIC’s security mission law became effective from 29th March 2021.
THE COSTS OF CFDS
Trading contracts come with their costs. It includes a commission, a spread, and the variation between the bid and the ask price. Commission costs are charged by some brokers, but recently most brokers do not charge any commissioner for placing trades.
Trading Currency pairs and Commodities do not require any commission. However, in stock trading, brokers charge a commission. The entry and exit of trade involve two different trades, therefore a commission is charged for each trade.
In some cases a financing fee is charged if you open a long position; this is because an overnight trade for an asset is deemed an investment. Traders are practically charged a revenue daily, according to the number of days the position is held.
For instance,
If a trader wishes to buy CFDs for the share value of GlaxoSmithKline, the trader opens a £10,000 trade. With the present price of GlaxoSmithKline being £23.50. The trader bets that the price of the share will rise to £24.80. The buy price spread is 24.80-23.50
The retail client plays a 0.1% commission upon placement of trade and another 0.1% when the trade is closed. For a trader going long, they will pay a financing fee, normally about 2.5%.
A retail client purchases 450 contracts at £23.50 per share, the open trade is worth £10,575. If the shares of GlaxoSmithKline increase to £24.80 within 16 days, the previous price of the trade was £10,575 but the present price is £11,160.
The trader’s income, before fees commission is £11,160-£10,575 = £585.
Since the charged commission is 0.1% when the trade is placed the trader is charged £10. Let’s say the interest charged per day for 16 days is 7.5%.
450 x £23.50 x 0.075/365 = £2.17.
The trade was open for 16 days thus, 16 x £2.17 = £34.72.
When the trade closes, the trader will pay another commission of 0.01% which is £10.
The trader’s main income is charges subtracted from the profit.
Profit = 585
Commission 10
Interest 34.72
Commission 10
Net profit =585 – (10+34.72+10)
585 – 54.75 = 530.25
Net profit = £530.25.
The PROS AND CONS OF TRADING CFD
Trading CFD comes with a lot of advantages, and everything that has an advantage also has disadvantages. Most traders always ask “is CFD worth it”? Well, let’s find out.
THE PROS OF TRADING CFDS
INCREASED LEVERAGE
Contracts give traders higher leverage compared to conventional trading. Normal leverage in the CFD market is highly restricted. In the past, it was restricted to a 2% cost margin which is 50:1 leverage. It further increased to a 3% cost margin being 30:1 leverage. But now it is at 50% margin cost which is 2:1 leverage. A lesser margin suggests less equity payment for the trader and higher profits.
However, using high leverage is dangerous; it can maximize both your profits and losses.
EASY ACCESS TO THE GLOBAL MARKET WHILE USING ONE TRADING PLATFORM.
Traders get access to products in global major markets. Thus, giving rise to steady market access from one trading platform. Traders are allowed to trade CFDs on a wide range of global markets.
NO RESTRICTIONS IN GOING SHORT OR BORROWING STOCK.
There are particular markets with rules that restrict short trades. Some markets impose the Trader to obtain the assets before going short. In other cases, the Trader is given a different margin regulation for long and short trades. A trader opens a CFD short trade without incurring any depth because they don’t own the underlying instrument.
NO FEE IS REQUIRED FOR THE EXECUTION OF TRADES.
CFD brokers provide several types of trade orders offered by conventional brokers. This includes stopping loss, profit targets, and important orders. Some conventional brokers charge a commission for providing guaranteed stops or find another way to implement the costs.
Brokers generate their income when a trader pays the spread. Sometimes, feeds and commissions are charged. To purchase or long the asset the trader pays the buy price, and to sell it off or go short the trader pays the bid price. The spread could be small or big, it is influenced by the volatility of the underlying asset; some assets have fixed prices.
DAY TRADING IS NOT REQUIRED
Some markets put restrictions on the number of days that can be processed with some particular accounts. Some markets impose a minimum amount of equity to day trading. The CFD market does not have any regulations, and all traders can trade as they wish. CFDs can be placed with as low as $1,000 equity. However, the most common minimum equity is $2,000 to $5,000.
DIFFERENT TRADING OPPORTUNITIES
Brokers presently provide Index, treasury, stock, Forex, and commodity CFDs. This allows traders eager in various financial instruments to trade CFDs a variety of exchanges.
NO STAMP DUTY
Contracts trading are structured to speculate the underlying market. When purchasing CFDs on Apple shares, for instance, you don’t buy the company’s shares directly. You only speculate on the price trends.
If you are doing conventional trading in the United Kingdom, you pay a stamp duty charge of 0.5% of open trades. This means CFDs are a better choice in this sense. Because you don’t purchase the underlying asset in CFDs, you don’t for the Stamp duty.
THE CONS OF TRADING CFDS
RETAIL CLIENT’S PAY THE SPREAD
It’s a known fact that CFDs provide an impressive alternative to conventional markets, however, they have their disadvantages. Paying the spread while opening and closing a trade is one. This factor removes the likely income from small trades. The traders winning and losing trades are also decreased by a small amount as compared to the underlying asset. So in essence, conventional markets expose a trader to restrictions, fees, commissions, and higher equities, CFDs reduce trader income via spread costs.
INEFFICIENT INDUSTRY REGULATION
The CFD market is not properly regulated. A good CFD broker does not depend on the government status or liquidity but instead on its reputation, economic position, and lifespan. Several CFD brokers meet these requirements. Ensure to make good research before signing up with any broker.
RISKS INVOLVED IN CFD TRADING
The contract market is vastly becoming a popular market and it requires proper regulation. Traders should be conscious of the associated risks with trading the market. Liquidity and Margins risk needs to be maintained. If your equity is not large enough to maintain price deductions, your broker could shut your trade. You must pay the loss irrespective of what comes about the underlying asset.
LEVERAGE
Trading with leverage exposes you to higher profits and also higher losses. Even though the limit loss order is provided by several CFD brokers, it is not a guarantee for not encountering losses. The market is unpredictable and when there is a sharp price trend and market closure, losses can be incurred.
EXECUTION RISKS MAY ARISE DUE TO DELAYS IN TRANSACTIONS.
However, The ESMA, known as the European Securities and Markets Authority, initiated new leverage ratios for CFD traders in March this year. This leverage ratio is based on the unpredictable nature of the underlying financial instrument.
EXAMPLE OF A CFD TRADE
For instance, if a stock’s asking price is $26.37 and a speculator buys 100 shares. The rate of the transaction will be $2,637 including commission and fees. In conventional trade, the trader needs about $1,318.5 for a 50% margin account. However, with a CFD broker, the trader needs a 5% margin which equals $131.85.
A contract trade indicates a loss that is equal to the amount of the spread at the time of entry. If the spread was 0.06 cents, the stock needs an extra profit of 0.06 cents for the trade to attain the break-even value. The trader makes a profit of 0.06 cents, if the trader bought the stock, they would have needed to pay for commission and a larger equity payment.
IS CFD TRADING WORTH IT?
Yes, CFD trading is worth it. Just like every other trade, it has its disadvantages and risks. But it has proven to be a good investment. Profits can be made in the trade, if only you know your ways around the market. Make sure to learn how the market works before going into it
However, CFD trading can be unpredictable, and the advantages can sometimes be outweighed by the disadvantages. There are a lot of risks involved, market volatility, liquidity risk, and counterparty risk. The poor regulation of the industry is also another risk factor, and the ability to sustain a sufficient margin due to losses incurred from leverage.
CAN YOU MAKE MONEY WITH CFDS?
Toe, money can be made through contracts trading. Nevertheless, the trading method can be tricky compared to other trading firms. To be a successful CFD trader, you first have to become a professional trader. A lot of experience and expertise is needed in this trading sector.
CONCLUSION
Contract trading is one of the ways traders generate income while avoiding some restrictions and fees. Although the trade is risky, it still serves its purpose which is to generate high profits. A Lot of measures need to be put in place to ensure successful trade. Use leverage wisely, because it can maximize your gains and also your loss.
