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CFDs come with a high risk of losing money rapidly due to leverage. 71% of accounts lose money when trading CFDs with this provider. You should understand how CFDs work and consider if you can take the risk of losing your money.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

79% of retail investor accounts lose money when trading CFDs with this provider.

CFD Trading

CFD trading pros and cons: the risks and rewards of trading CFDs

risks and rewards of trading cfds image representation with risk and rewards values in screens in a trading floor

To discuss CFD trading pros and cons, you first need to define the abbreviation CFD. A CFD is a contract for difference, which is a financial instrument that allows a trader to go long or short on an underlying asset without taking ownership of it.

In simple terms, CFDs allow you to trade the price movements of something without owning it.

For example, when you buy stocks in a company, you own a piece of that company. Therefore, you have a stake in its financial fortunes. When its value increases, so does the value of the stocks you own. When the company’s value decreases, the stocks you own lose value.

Stocks are the underlying asset in this example. When you trade stocks CFDs, you don’t own the underlying asset. You don’t have a direct stake in the company’s fortunes. Instead, you have a contract that derives its value from an underlying asset (stocks in this example). The contract stipulates that the buyer must pay the difference between the current value of an asset and the value at the time it was executed.

So, if you executed a stocks CFD, when the price was $10 and, when you came to sell, the underlying asset (i.e. the stocks), was priced at $20, you’d receive the difference between the two figures. So, in this case, you’d make $20.

Because you’re trading on price movements instead of buying the underlying asset, you can take either side of the coin. You take a long position if you think the price of the underlying asset will increase, or you can take a short position if you believe the asset’s value will decrease.

The risks and rewards of CFD trading

CFD trading can be described as a flexible strategy because you’re able to go long or short. However, this ability to take either position can present some problems, particularly if you’re a novice. Therefore, CFD trading for beginners isn’t as simple or as risk-free as it might seem. With this in mind, here are CFD trading pros and cons.

The Potential risks of CFD trading strategies:

There are Costs Involved
CFD trading isn’t free. Brokers use something known as the spread to cover their costs. The spread is the difference between the buy and sell price. This small cost has to be factored in. For example, CFD trading strategies that require you to move into and out of positions multiple times per day (i.e. day trading) can be costly because you have to cover the spread each time you buy and sell.
CFD Trading Rules Can Vary
One of the CFD trading pros and cons you need to think about is regulation. The rules for trading CFDs can vary from country to country. Therefore, make sure you know how to trade CFDs in your location.
Leverage, Margin and Liquidation Risks
Using leverage can lead to exponential losses when a trade doesn’t go your way. You can read more about leverage and its risks and rewards in CFD trading in the next section. Trading with leverage (on margin) can cause you to lose money faster than usual. This can lead to your position being liquidated due to a lack of funds.

The potential rewards of CFD trading strategies:

Can Take Long or Short Positions
We’ve mentioned it already in this guide to CFD trading pros and cons, but it’s worth repeating: you can go long or short on an underlying asset. Because you’re speculating on price movements and not buying the underlying asset, you can trade on its value increasing or decreasing.
Trade Multiple Products
CFDs are available for a variety of products. There are risks and rewards to trading all types of CFDs. You can trade CFDs for stocks, forex, commodities and other financial instruments.
You Can Use Order Limits
You can use stop-loss and take-profit limits to control risk when trading CFDs. The former will automatically close a trade when your loss hits a predetermined amount. The latter closes a trade when you’ve reached a predetermined amount of profit.
You Can Trade with Leverage
We can’t mention the risks and rewards of CFD trading without discussing leverage. Using leverage in trading means you’re taking a position with a small amount of your own money and funds “borrowed” from a broker. The difference between the amount of money you commit to a trade and the amount of money you borrow is known as the margin. So, when you leverage up your money using borrowed funds, you’re trading on margin.CFD trading allows you to take higher leverage than other financial instruments.

For example, it could be possible to get leverage of 30:1. This means that the broker will put in 30 units for every one unit you commit. Trading with leverage means you can take a bigger position for a smaller outlay. With a bigger position, you have the opportunity to make more profit.The counter to this is that you can lose more money when you trade on leverage.

As we said in the previous section of this CFD trading pros and cons guide, a major risk is exponential losses. This is where the losses you experience are multiplied due to leverage. If your losses mount up sufficiently, your position could be closed due to a lack of funds.

The assets you can trade with CFDs

Learning the CFD trading pros and cons is important. However, you can’t develop potentially profitable CFD trading strategies if you don’t know what’s available to trade. Here are some of the assets you can trade CFDs for at Skilling:

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Trading vs. investing: what is the difference between trading and investing?

The major difference between trading and investing is the time you hold a position. Investors will buy an underlying asset and hold it for a long period because they believe it’s going to increase in value.

For example, an investor might buy shares in Tesla because they think the company’s value will go up.

In contrast, a trader will react to the market. That means a trader is more likely to make shorter-term moves. For example, they might buy Tesla shares when the market is bullish and sell when it switches to bearish. An investor would be more likely to hold their position during these changing conditions.

Because a trader is moving into and out of positions more frequently, CFDs can be useful because it’s possible to take long and short positions. Also, a trader isn’t buying the underlying asset. Therefore, they’re not as psychologically committed to the asset’s long-term value.

CFD trading for beginners: important terms you should know

We’ve discussed some of the main CFD trading pros and cons. Within these risks and rewards, we mentioned a few things you need to know, particularly regarding CFD trading for beginners. Here is a reminder of some of the key concepts:

  1. Margin: This is where you’re trading with leverage, i.e. borrowed funds.

  2. Commissions: The small fee you have to pay, i.e. the commission a broker takes on each trade, is known as the spread.

  3. Stop-Loss Order: You can set a stop-loss limit via your trading platform which means a trade is automatically stopped when a certain amount of loss is incurred.

  4. Swaps: Equity swaps are a derivative much like CFDs. However, unlike CFDs which don’t have a set expiry date, swaps are contracts that stipulate a date at which the contract has to expire on/before.

Next steps: trading CFDs online

That’s just about all you need to know about the risks and rewards of CFD trading. Before you join Skilling and test out various CFD trading strategies, check out these articles to learn more about these financial products:

  • Click here to learn more about the basics of CFD trading.
  • Click here for our articles on trading, including CFD trading strategies.
  • Click here to create an account and trade CFDs online.

Not investment advice.