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

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:

The potential rewards of CFD trading strategies:

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.

Not investment advice.