Advantages of CFD Trading

As in the case of any kind of investment or trading tool, CFD trading also has its share of advantages. However, there are also some aspects of CFD trading that you may need to watch out for. Before you start to think of the things that you need to be careful when engaging in CFD trading, here are some great reasons why CFD trading is a great option.

Even though blue chip stocks may give you a fair amount of gain in the long term, the fact is that the whole buy is also extremely high risk too. Choosing penny stocks instead is also not a great strategy. The fact that CFD trading provides you with a fair amount of liquidity due to the leverage is a great factor to consider.

While trading short can be an issue in some kinds of assets, markets and exchanges, there is never an issue in trading long or short when it comes to CFD trading.

It is also possible for a trader to indulge in CFD trading in a variety of products like forex and foreign currencies, commodities, energies, metals, rates and bonds and stocks too. This means that you can choose from a large variety if you want to or stick to one type of asset and gain expertise in it.

While options have an expiry date, there is no expiry date when you choose CFD trading. There is the option of holding onto a position if you feel that the asset has more upside to it.

All That You Would Want To Know About Margin Requirement in CFDs

One of the advantages of CFD trading is that of not having to put up as collateral the full notional value of the CFD. This means that a given amount of capital can control a larger position, which amplifies the potential for profit. At the same time, you stand to lose a substantial part of the margin money in the event of a downturn in a volatile CFD.

A CFD provider allows you to create long or short positions in any CFD. There are normally two types of margin requirements: Initial Margin and Variation or ongoing margins.

Initial margin is the amount you are required to maintain in your account for as long as the position is open. This may vary from 3 to 30 percent on shares and commodities and 0.5 to 1 percent on indices and foreign exchange. Initial margin is fixed on the basis of the underlying reference instrument of each CFD and the perceived risk in the underlying market.

Variation margins or margin on ongoing basis is applied to CFD positions if they move against you. If you were to buy 1000 shares using a CFD at 1 dollar and the price dropped to 90 cents, the CFD provider with deduct 100 dollars as ongoing margin. On the other hand, if the price were to group by 10 cents, your account will be credited by the same amount as running profit. Ongoing margin is also known as ‘marked to market’ as it is deducted or paid in your CFD account on real time basis.

On the other hand, the initial margin is deducted from your account when you open a CFD position and is replaced only after you close the position. 

Stock Index Futures and Index Future CFDs

Index futures and/or index futures CFDs refer to a basket of top stocks traded in an exchange. Similarly, sector index CFDs refer to top stocks within a specific industry. A bank index, for example, has top banks as its constituents.

An index or sector futures contract is an agreement to buy or sell an index at a specified future date at an agreed price and a cash settlement occurs on expiry of the contract. Index futures CFDs on the other hand are not settled for cash but automatically carried over to a new date by the product provider.  

CFDs are contracts for difference and you trade in the underlying reference instrument (in the present context, an index futures contract) without actually owning it. Your trade for the price fluctuations and your profit or loss is the difference between the price when you enter and exit a position. The counterparty in CFDs is the CFD provider with whom you must complete all transactions in relation with the position you open. All closing positions must necessarily be equal and opposite of the open positions.

Index futures CFDs are derivative products just like index futures contracts but the problem with trading directly on a futures exchange is that there are standardised contracts that specify position size and expiry date. In contrast, CFDs are customised derivative products without a standard form. CFDs are also simpler to understand as they trade at the spot price with a small commission or the providers spread reflected as the difference between bid and offer quotes.

However, there is a risk involved in CFDs because they are offered over-the-counter and not regulated products. Much depends upon the credibility of the broker you choose to trade with.

Trading CFDs on the long and short

Have you ever wondered how a seasoned trader trading in CFDs makes money even when the market is going down? The reason is that you can make money trading CFDs in a rising as well as a falling market. 

Trading CFDs means that you take a position on the basis of how you expect the price of the underlying reference instrument of the CFD to move.   

Trading CFDs on the long and short is a technique where you go long when you are expecting the market to rise and go short when you expect it to go down.  

A long position is set up by initiating a buy order as your opening position and sell order when you close the trade. Similarly, a short position is created when you initiate a trade with a sell order and close by placing a buy order. 

The next crucial aspect of trading CFDs is that opening and closing trades must be equal and opposite of each other. When trading CFDs if you open with a buy order, you close it with a sell order and the other way round. If you have created multiple positions while trading CFDs, you can close them with a single closing trade. 

Whichever way you do it, the profit that you make or the loss you book in trading CFDs is the difference between the value of the opening and closing positions, net of any charges that you must pay or the benefits that accrue to you in relation to the CFD.