Contracts For Difference are an exciting way to get involved in the financial markets without actually purchasing any physical assets. They are one of the more popular forms of derivatives mainly due to their ease of use and the leverage typically available and are traded across the globe.
How does a CFD work?
When you open a contract with a broker, you are agreeing to settle at a future point in time, the difference between the opening and closing prices of an underlying asset, multiplied by the number of shares in the contract.
If the price of the asset moves in your favour, the broker will pay you your gain while the opposite is true if the price moves against you. We will use an example to explain this in more detail, shortly.
When you login to a broker’s platform, you will see that CFDs are traded in a very similar way to shares. Prices will move in-line with the underlying share price and will be affected by fundamentals and outside economic factors.
The number of markets available through the top CFD trading platforms is truly staggering. You will often find that all top FTSE Shares are catered for as well as US and other global stock. Some brokers will even trade AIM shares but the spreads and fees are normally more than with the more popular stock.
Advantages of trading CFDs
When compared to traditional share dealing, there are a number of benefits of using CFDs instead.
Trade on Margin
First and foremost you are able to trade on leverage. Leverage essentially allows you to borrow stock against the funds you have in your account. When you open a position, you might only have to pay 10% of the value of that position. By using leverage, you are able to benefit from far higher profits but consequently, if the market moves against you, your losses can spiral much faster too.
Go Short or Long
When investing into shares through stock brokers, you are only ever able to go ‘long’. This means that, due to the nature of share trading, you can only benefit from prices going up. This can be quite restrictive, especially if you are witnessing a downturn in a share price or if you expect negative news to be released that will adversely affect a share. With CFDs, you can go short, allowing you to benefit from a drop in price – one of the main reasons people use CFDs as a means of speculation.
Choosing a CFD Broker
There are a number of things you should assess before depositing money with a CFD broker. We will discuss each of the in turn.
Firstly, you need to check whether the broker actually offers the market/s you are interested in trading. Not all companies offer access to AIM stocks, for example, so if you’re intending on buying contracts on more speculative plays then you should contact the broker first. IG Markets probably o offers more market choice than any other broker on the market, along with TD Waterhouse.
Secondly, a very important question to ask is what fees the company charges. The amount will vary, depending upon the broker’s fee structure and the markets you are trading on. It is worth contacting a number of different companies to find out which is the cheapest, especially if you are opening high value trades or planning to trade regularly.
Another aspect to weigh up is the platform that you will be trading on. Our advice would be to sign up for an account with a few of the most popular brokers that offer demo accounts. Have a play around with each and go for the one that best suits your trading needs. If you are going to be trading using technical analysis then MT4 will probably be a minimal requirement. Does the company offer a mobile version of its platform? Most of them do, but if you are planning on trading on the move then you will want to make sure a mobile app is an option.