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Wednesday, April 29, 2015

CFD Trading - Weighing the advantages and risks

By Kumarpal Shah

A CFD (contract for difference) is a contract entered into between a buyer and a seller. These agreements allow buyers to purchase an asset at the price difference between the asset's current value and its value at the time it was placed on the market. CFDs are popular among financial investors because they allow traders to take advantage of profits in various markets without actually owning the assets being bought and sold. CFDs are quick, accessible, and easy to share; they can also prove to be profitable in times of a declining market because their ability to be traded for long or short positions. 

The Pros of CFD Trading 

Why trade CFDs? There are many reasons. As stated above, CFD trading does not require the individual managing the trades to actually own the assent being sold or purchased. This is a huge positive for many people because it doesn't require them to invest large sums of money in multiple physical properties simply to profit off of general market sales. 

CFDs are also traded on margin, which allows traders the opportunity to enhance the capacity of their investments, and experiment in other booming markets. The minimum amount required to be paid up front by the trader is 5% of the CFD, a minuscule amount when compare to traditional share margins. Because of this fact, CFDs are also affordable for the first-time trader. CFDs are able to be sold long or short. Long position selling allows traders to hold the asset in hopes of it increasing in value over time, while short position selling allows traders to sell the assent immediately in order to profit prior to a drastic decline in the market. It is this versatility in long or short position trading that makes CFDs potentially lucrative for many traders. 

 The Risks of CFD Trading 

As with any financial investment, choosing to trade CFDs can come with a wide variety of risks. Despite the smaller margin, the risk factor of contract for difference trades is just as high as a traditional face value stock purchase. This means the trader's CFD investment is more likely to fluctuate than a standard share purchase is. Also because of this reason, CFD trades hold the risk of the trader losing more than the 5% they initially invested. The amount of these losses can reach or exceed triple of the investors initial investment. Finally, because CFDs are derivative assets based on the trader's assumption of the market's increasing or decreasing value, there is always a potent market risk that plagues any CFD trader. Small fluctuations in the industry's profitability are capable of having a major impact of the profitability of the trader's position. 

Despite these risks, CFDs can be secured by implementing limit orders or stop losses to avoid holding onto the agreement past it's time of profitability. CFD trading can be a highly lucrative investment if the risks are thoroughly studied and respected. Understanding that managing current CFDs rather than continuing to accumulate more contracts is a better time investment is a must for those seriously considering trading CFDs. 

About the author: This guest post was written by Kumarpal Shah. He is a financial investor and copywriter. He shares his knowledge with investors to help them.

Image: Pixabay, US-PD