Using CFD Trading As Your Only Source of Income: Is It Worth the Risk?
A Contract for Difference (CFD) is a financial agreement concluded between an investor and a broker. CFDs enjoin both participants to cash settlements, whose amount is the difference between the opening value of a share or some other tradable financial asset and its closing value at the end of the contract. When trading CFDs, investors speculate on the short-term movement of price in either direction.
While there are quite a few appealing advantages to CFD trading, this high-risk investment strategy can easily leave you with nothing but sorrow should you trust the wrong broker or choose to enter the market too soon, without having any special skills or necessary intel. To make sure you know what you are getting yourself into, see our list of pros and cons of investing in CFDs and read on for more recommendations on how to diversify your investment portfolio to safeguard your hard-earned cash.
Benefits and Downsides of CFD Trading
If you are not entirely sure that CFDs are the right trading instrument for you, it always helps to do more research on the subject and see what pitfalls and potential benefits there are. Alternatively, save your time and read our overview of both.
Pros of CFD Trading:
- Liquidity. CFDs grant access to the underlying market liquidity in addition to what the CFD provider offers.
- The ability to trade on margin. With no need to deposit the full value of traded shares, investors can increase their returns and use their capitals more effectively.
- Greater tax efficiency. You are likely to enjoy some tax benefits with CFD trading, such as deductible interest repayments.
- Reduced transaction costs. Brokering CFDs is usually considerably cheaper than purchasing stocks. Most of the time, you are not charged to open or close a position and have to cover the spread only.
- Simple execution. Trading or investing with CFDs is a lot like trading with shares. The rules are transparent and easy to understand.
- Selling short is as easy as going long. With CFDs, you can choose to trade both long and short positions. If you feel that an overvalued stock is subject to a correction, you can sell it with ease, no stockbroker’s participation is required.
- No fixed expiry date or contract size. CFDs do not have the fixed time limitations of futures contracts, meaning you can trade any number of shares and within any time frame.
Cons of CFD Trading:
- It is easy to lose everything. CFD investors and traders that are trading with leverage must remember that when a position goes down below a certain point, it simply closes out, and you lose your initial margin.
- Overtrading is a real possibility. Ease of access combined with low capital demands and overall swiftness of dealings can result in overtrading. It is a common mistake for inexperienced traders who are too quick to open and close new positions.
- There is a financing fee to cover. Maintaining a position open overnight or for the whole weekend means you will be charged a financing fee. Such a payment is only taken if you open short positions or trade with leverage and does not apply to no-leverage, long stock trades.
Investing In CFDs: Is It a Go or a No Go?
For all its obvious benefits, CFD is a highly speculative and risky form of investment. One must have a practical long-term investment strategy supported by a great deal of self-discipline and composure to make it work.
If you do not feel like going all-in with CFDs, there are alternatives, such as futures and options contracts that will help you diversify. Admittedly, they have a more complex trading strategy and might require a skill set that not many low-level traders possess, so you will have to up your game before you can take full advantage of these tools.
Which option do you think a first-time trader should start with? Can the flexibility and low entry threshold make up for the risk associated with investing in CFDs? Use our comments section to share your tricks of the trade with our readers, and feel free to recommend this post to your friends!