CFDs provide traders with all of the benefits and risks of owning a security without actually owning it or having to take any physical delivery of the asset.
CFDs are traded on margin meaning the broker allows investors to borrow money to increase leverage or the size of the position to amply gains.
Trading on margin CFDs typically provides higher leverage than traditional trading.
Lower margin requirements mean less capital outlay and greater potential returns for the trader.
The CFD industry as less regulation as compared to standard exchanges. As a result, CFDs can have lower capital requirements or cash required in a brokerage account.
Often, traders can open an account for as little as $500 with a broker. Also, since CFDs mirror corporate actions taking place, a CFD owner can receive cash dividends increasing the trader’s return on investment. CFD brokers offer products in all major worldwide markets. Traders have easy access to any market that is open from the broker’s platform.
CFDs allow investors to easily take a long or short position or a buy and sell position. An instrument may be shorted at any time.
Brokers make money from the trader paying the spread meaning the trader pays the ask price when buying, and takes the bid price when selling or shorting.
Risks of a CFD
If the underlying asset experiences extreme volatility or price fluctuations, the spread on the bid and ask prices can be significant.
Paying a large spread on entries and exits prevents profiting from small moves in CFDs decreasing the number of winning trades while increasing losses.
Since the CFD industry is not highly regulated, the broker’s credibility is based on its reputation and financial viability. As a result, CFDs are not available in the United States.
Since CFDs trade using leverage, investors holding a losing position can get a margin call from their broker, which requires additional funds to be deposited to balance out the losing position. Although leverage can amplify gains with CFDs, leverage can also magnify losses and traders are at risk of losing 100% of their investment. Also, if money is borrowed from a broker to trade, the trader will be charged a daily interest rate amount.
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