In recent years, more and more people have started to realise that keeping their money in bank accounts generates minimal profit for them. Banks have been quite hesitant to offer attractive interest rates to their clients, especially after the 2008 financial crisis hit the US and subsequently transmitted to the European economies in 2009.
Despite the US Federal Reserve’s (FED) and the European Central Bank’s (ECB) expansionary monetary policies, bank depositors are still hurt by low interest rates. Low interest rates are always acting as a disincentive when it comes to savings. As a result, people are trying to find new ways to invest their hard-earned money and make a profit that would improve their living conditions.
Stock markets are always offering new profit possibilities. Shares, commodities, derivatives, are just some of the products that you can invest in the stock market. One of the derivative products that dominates financial markets is the Contract For Difference or CFD as it is the acronym used by brokers.
What is a CFD?
CFDs are leveraged derivative products, entered into for speculative purposes and traded on an ‘Over-The-Counter’ basis and through a Regulated Market or Exchange. CFDs work by acting as a contract to exchange the difference in value of an asset between the point at which the contract is opened and when it is closed. The leveraged nature of the product means that the effects of small movements in price are multiplied and may have large impacts on the value of trade positions, both in respect of profits made and losses incurred and the higher the leverage rate, the higher the risk involved. In addition, the nature of leverage means that losses may exceed the amount of the total amount of an investors’ invested capital, when entering into a CFD contract, unless the trading account has Negative Balance Protection in place.
Trading a CFD requires the potential investor to have sufficient knowledge and experience to understand the nature and the risks involved in trading CFD leveraged derivative products. CFD trading has to do with speculating on the drop or the surge of prices for a broad variety of financial instruments. These instruments can be shares, commodities, bonds, currencies and indices. One of the main advantages of CFDs is that the investor doesn’t have to actually own the instrument as it would happen, for example, with a shareholder. Investors are buying units of a CFD instrument but not the underlying financial instrument itself.
CFD basic principles
As it was said before, the investor is not required to own the instrument. However, an investor would be required to deposit only a small amount of capital to support the value of the trade (which has a larger exposure), in order to open a position. In the language of the financial world, this is called “Margin” or “trading with margin”. Margin trading requires extra caution, because whilst an investor can realise large profits if the price moves in their favour, an investor can also risk extensive losses if the price moves against them.
Spread is one more word that a potential CFD investor should understand. Spread is the difference between the buy and the sell price quoted for an instrument. The spread cost is realised each time an investor opens and closes a trade. In case an investor places a trade and the price of the instrument moves in his favour beyond the spread’s cost, then the trade is a profitable one. Conversely, if an investor’s CFD trade is closed at a less favourable price, this can work against the investor and they can experience extensive losses. In order to make it more clear, the spread is one of the key costs involved in CFD trading, therefore tighter the spread, the better value a potential trader is getting.
Who can consider CFD trading?
Anyone who has an interest in diversifying across a range of investments, wants to realise and experience the potential benefits of CFD trading, whilst also understanding the nature and the risks involved in trading such products. Investing in financial markets are a way to achieve that, especially as people nowadays have access to global financial markets via the Internet. However, this doesn’t mean in any way that all investments products and services are suitable for everyone. If an investor is uncertain about the suitability or appropriateness of a financial product such as CFDs, for their personal circumstances, they must consult an independent professional financial advisor before engaging in investing in the financial markets.
CFD trading is potentially an appropriate solution for:
• People who want to have total control over their investment decisions and who prefer to form their own investing strategy.
• Investors with short-term trading goals. In some cases, intraday trading and CFDs are generally not appropriate for long term investments. There is no recommended holding period, no cancellation period and therefore no cancellation fees. CFDs can be opened and closed at any time during market hours.
• People that would like to diversify their investment portfolio. CFD trading offers the chance of trading in various asset classes worldwide.
• Investors who don’t want to use their entire capital into just traditional financial instruments such as stocks, shares and bonds, but want to take advantage of the inancial markets using CFD leveraged products. They are able to take advantage of CFDs being leveraged products.
• Investors that want to use CFDs as part of their hedging strategy, when markets show substantive increases in volatility to, so as to potentially protect their
investments from unpredictable and sometimes extreme movements in price by seeking a balance between asset exposure and potential losses.
Why choose STO for trading CFDs?
Registering with STO will give you the opportunity to select from 5 diverse account types, depending on your budget and needs. STO is offering tight and competitive spreads, fast execution, low or no commissions at all and a 24/5 multilingual support ready to assist you in forming your own profitable investing strategy.