Contracts for Difference (CFD) trading is one of the latest trends for investments. Many traders in Kenya have started using advanced technology platforms that can become a profitable way to capitalize on the global economy. A CFD is tied up with an underlying asset, and investors have to only worry about the pricing of that asset.
A CFD is defined as a financial contract between a broker and a client to pay any difference between the opening and closing price of the stocks at the end of a designated period. So you may feel that it is the same as traditional stock trading.
However, there are some differences between CFDs and regular stock trading. In this article, we are going to discuss those differences along with the various advantages and disadvantages of CFD trading.
One of the best things about CFD trading is that you can speculate whether the underlying asset will gain or lose points. In the trading language, it is called opening long and short positions in the trade. That means when you buy a long position, you will profit when the underlying asset gains points and lose money if the asset losses points.
When you buy short positions, you will make money when the asset losses market value and vice versa. That allows you to purchase more CFD stocks from various countries like the UK, Germany, USA, and take advantage of the rise and fall in prices. However, be aware that even though shorting a stock can feel like an easier option at times, it is riskier than choosing the long position.
Most CFD brokers offer immediate execution of orders, which means you can open or close positions as soon as you want. When you are trading in traditional stocks, international brokers can take days to settle your trades. That means it can take a lot of time for the money to come into your bank account in Kenya.
However, since CFD brokers can close the trades instantly, you can get instant access to your capital. That means the money can get deposited into your bank account immediately. But remember, the money will get debited from your bank account immediately as well.
When you are trading in CFDs, you can take advantage of something called leverage. Your CFD broker would offer leverage on the purchase of the stock. For example, you want to buy 10 positions on a stock valued at 500 points. That means the total value of your trade would be $5000.
However, with CFD, you can buy the stocks with only a small percentage of the total amount. If your broker offers 99:1 leverage, that means you only need to pay 1% of the total amount, and your broker will stake the rest. So you can buy the CFD stocks for only $50. If the value of the asset goes from 500 to 600, and you have bought a long position, you can make a profit of $1000.
Nevertheless, if the value goes from 500 to 400, which means you would end up losing $1000 as well, and you will have to pay the rest of the amount. That means you can lose more than you invest at times, so you would need to have that money present in your account.
When you are trading in CFDs you will be charged much lower fees and commissions than traditional stocks. Traditional stockbrokers will charge an opening and closing commission per stock. That means you would need to make a profit of that amount even before you start making a cent from the deal. Most CFD brokers will not charge you a commission to open or close a position.
Although, there are certain other charges that you must bear. If you are taking leverage from your broker, you would also be charged a financing fee, especially if you want to keep the position open overnight or over the weekend. The financing fee is your broker passing on the interest of keeping the position open over to you. That means you would need to factor that in with your trade.
CFDs may not be as complicated to understand, but they can be quite risky at times. You must understand that the more leverage you have, the greater the risk of losing money. There are very few regulatory bodies so over the world that supervises CFD trading. Therefore, you must have a thorough understanding of all aspects before you begin trading. Also, choose reputable brokers who would take you through the entire process before you begin trading.