Aside from being more flexible and cost-efficient, CFD trading offers many advantages over traditional stock trading, such as lower commissions, increased leverage, greater diversification, and the ability to go both short and long on equities. This article lists down 12 reasons why this form of trading might be perfect for you.
Brokerage accounts charge commission per transaction. On top of that, traders also shoulder other fees like access fees and clearing fees, among others. For new traders starting out with a small capital, this can be real draining on profits. Luckily, commission rates on CFDs are typically much lower than on traditional share trading, allowing you to trade more actively for minor price movements. This makes share CFDs a more cost-effective means to win trades, especially for starters.
One of the major advantages of trading CFDs is leveraged returns, which often bring in significant gains. Leverage basically means you get to borrow money for trading. Although it involves a certain level of risk, it’s a great return strategy if managed well.
Leveraged trading lets you use only a fraction of what you would have spent in cash, so you can continue keeping your cash somewhere else, in fixed income or liquid assets. This means you get more than one source of income from a single pool of money.
As mentioned though, there is still risk involved here so stick to the universal rule of trading: don’t trade more than you can afford to lose. If managed poorly or if the market moves against your position, leverage can lead to significant loss.
CFD trading exposes you not only to local stocks, but also to international stock, indices, commodities, foreign exchanges, and more. Cash stocks, on the other hand, set more limitations as to what you can trade, not to mention the higher costs that often come with the exchanges.
Being able to trade in a wide array of financial assets will allow you to diversify and reduce concentration risks. However, keep in mind that one essential rule of diversification is to not put all your money in a single market. Take advantage of multiple instruments across different markets and you improve your shot at success by a considerable degree.
Short and Long Positions
CFDs allow traders to hold both short and long positions. The advantage of this is that you gain either the stock moves down or moves up, meaning you still profit from a down-trending market. Since you have opportunities on both the short and long positions, you no longer need to wait for the stock market to recover to make up for any loss. Cash stock accounts don’t offer this.
More reasons to trade CFDs:
- CFDs are fairly easy to learn and trade than warrants or options.
- You can buy and sell CFD positions instantaneously as there is no settlement period required when closing one.
- If you don’t hold your position open overnight, there will be no financing charges. When you trade short positions, you will get interest payment for each day that you hold the position open.
- As you hold your positions only for a short timeframe, your cash is not locked up. So when a trading opportunity emerges, you will still have enough funds to take the trade.
- With CFD, you’re only trading on margin. That means you don’t need to pay the full value of the stock you’re trading. You only pay a margin or deposit to cover any possible loss on a position. This improves the risk/return on your trading capital.
- You can take advantage of Pairs Trading, that is, a trading strategy in which you trade two corporations whose share prices are not in-sync with their typical correlation. You take similar stocks within a certain sector (for example, BP and Shell) and go ‘short’ on the apparent overvalued share and ‘long’ on the apparent undervalued share.
- Unlike in stocks, you don’t need to sell out of a winning position in CFDs just so you can take advantage of the increased price.
- You are reducing risks because you aren’t exposed to the possibility of share CFDs gapping down or up overnight, as caused by global market movements.
CFDs are an excellent trading tool because of easy access, transparency, flexibility, cost-efficiency, and because of the reasons mentioned above. Improve your trading portfolio by adding CFDs to your toolkit and learning the fundamentals of the trade.