From an investor’s perspective, there are many advantages that can be captured when entering into the world of CFD trading. It have become increasingly popular in recent years as widespread media reports have shown that CFD accounts offer substantial advantages when compared to traditional forms of investment. Brokers give investors all the financial benefits of shares trading, without having to physically take possession of those shares.
Profiting in Bullish and Bearish Markets
One common misconception in many new traders is the idea that gains can only be achieved when markets move higher. The flexibility of these contracts, however, allows for “short selling” positions to be established, which accumulate gains when prices are in decline. Since prices cannot always move in one direction, a clear benefit here is that traders can capitalize on market moves seen in both rising and falling markets, allowing for maximum gains to be achieved.
When markets are rising (sometimes called an “uptrend” or a “bull market”) raders can purchase a CFD position (sometimes called a “long” position), and then sell that position at a later date to close the trade. When markets are falling (sometimes called a “downtrend” or a “bear market), traders are able to sell a CFD position initially, and then later buy it back to close the trade. In trading jargon, this is often referred to as “short selling.”
In addition to this, CFD brokers allow you to use your capital more efficiently through leverage, where position sizes can be increased with only a small initial capital outlay. For example, when using 10:1 leverage, a trader can command a trading position worth $10 for every Dollar invested (i.e. a trading position that is ten times as large). This can allow traders to magnify gains but it should also be remembered that losses are equally magnified. CFD trading with leverage requires a greater level of caution than traditional shares trading.
One of the most attractive advantages of CFD trading is that traders are not required to pay the stamp duty and will not incur safe-keeping custody charges, since no physical purchase is actually being made. The flip-side of this is that traders do not have any voting rights that are often afforded to traditional investors. Because of this, CFD traders should understand that this type of investment is more well-suited to different types of investment goals.
Another commonly used CFD trading strategy is “hedging,” as CFD positions can be established as both longs and shorts. Hedging allows traders to assume offsetting positions as a protective measure during times of enhanced market volatility. For example, long term investments can be protected from short term fluctuations in market prices using CFDs. Assets that are highly-correlated can be bought in one case and sold in the other, and this will mitigate any losses seen when prices move in an unexpected direction. If the value of the long term asset holdings drops, gains will be seen to an equal degree in the trades, thereby eliminating the total losses and bringing the balance back to even levels.
When discussing “highly correlated” assets, we are looking at assets that tend to perform similarly in all market conditions. For example, if we look at Exxon and British Petroleum (BP) stocks, we would expect a similar performance in most market environments. Of course, there will be some price differences given that markets will be assessing the performance of the two different companies but when looking to hedge assets, a buy position could be taken in Exxon and a sell position could be taken in BP. The balance of these two positions will even out in most cases, and protect against any unexpected volatility in the energy markets. A similar CFD trading strategy could be used in any industry sector, such as health care or computer technology.