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Understanding the Pros and Cons of Contracts for Differences (CFDs)



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A Contract for Differences (CFD) is a progressive trading strategy that experienced traders use. In this post, we shall discuss some of the advantages and disadvantages of CFDs. 

The Pros of CFDs

·         Higher Leverage

CFDs offer higher leverage than conventional trading. Regular leverage in the CFD market is exposed to regulation. In the past, leverage was at a 2% or 50:1 maintenance margin. Currently, leverage is limited in a 3% or 30:1 range and can even increase up to 50% or 2.1 leverage. Lower margin demands indicate a low capital outlay for the investor or trader and higher potential returns. Still, high leverage can intensify losses. 

·         Accessing the Global Market from One Platform

Many Contracts for Differences brokers provide products in all major markets globally, facilitating round the clock access. Investors in MENA Region can trade CFDs across a vast range of more than 4,000 markets around the globe. No Stock-borrowing or Shorting Rules.

Some markets have rules that forbid shorting and demand that traders should have varying margin requirements for long and short positions. Further, a trader should borrow the asset before shorting it. CFD assets can be shorted at any time without financial costs if the trader has no underlying security. 

·         Professional Execution without Fees

CFD brokers offer numerous but similar order types as conventional brokers like limits, stops, and contingent orders (if done and one cancels the other). Some brokers who offer guaranteed stops often charge traders a fee for the service or recover costs differently. Brokers generate money when a trader settles the spread.

Many brokers hardly charge commissions. To purchase the spread a trader must compensate the ask price while to short or sell, they must compensate the bid price. This spread can either be large or small based on how volatile the fixed spreads and underlying security is.  

No Day Trading Demands

Some markets need minimal amounts of capital to either:

  • Trade during the day, or 
  • Restrict the number of day trades an investor can make within some accounts. 

These restrictions do not bind the CFD market. All investors can participate in day trading provided they own an account. Traders can open accounts for up to $1,000. However, $2,000 and $5,000 are average margin deposit requirements. 

Disadvantages of CFD Trading

·         Traders Settle the Spread

Contracts for differences may give investors an attractive alternative to traditional markets. However, they also come with potential risks. For example, paying off the spread on exits, and entries bars traders from profiting from small moves. What’s more, the spread also reduces winning trades by a little margin as opposed to the underlying asset.

It also increases losses by a small margin. Conventional markets expose traders to regulations, fees, increased capital requirements, and commissions. However, CFDs scale down a trader’s profits through spread costs. 

·        Risks

CFD trading is a fast-moving industry that needs close monitoring structures. There are some margins and liquidity risks you should maintain. If you cannot contain reductions in values, your provider is likely to close down your position. Even then, you will need to assume responsibility for the loss regardless of what happens to the underlying security.

Leverage dangers expose traders to high potential profits and increased potential losses as well. Even though many CFD providers offer stop-loss limits, they cannot protect you from losses involved. 

·        Shaky Industry Regulation

The CFD trading industry is hardly regulated. What this means is that the credibility of brokers depends on longevity, reputation, and financial position, as opposed to liquidity and government position. While there are some reputable CFD brokers in the industry, traders should always scrutinize a broker’s background before opening an account. 

Finally

CFD trading offers attractive advantages, but traders should beware of the cons too. Understanding the disadvantages of CFD trading protects you from incurring big losses.