Thinking about jumping into CFD trading? You’re not alone. Experienced traders are drawn towards Contract for Differences (CFD) trading due to its flexibility and profit potential.
But here’s the thing: CFD trading isn’t just about making quick trades. There are numerous risks and costs involved. Whether you’re a beginner or a seasoned trader, knowing what CFD trading entails can make a big difference. Let’s break it down.
CFD Trading is a High-Risk Venture
There’s a reason why CFD trading is often recommended for experienced traders. When you invest in CFDs, you’re not buying an asset, but speculating on the price of that asset. Traders enter into a contract with the broker, where they’ll either profit or lose depending on the difference in the asset’s price when the contract opens or closes.
Here are three ways CFD traders can manage risks:
- Use a demo account to test your strategy before entering the live market.
- Use stop-loss orders to limit your downside.
- Choose a broker that offers multiple accounts with low spreads to minimise costs.
Choosing a Reliable CFD Broker is Important
Your CFD broker can make or break your trading journey. It acts as a platform, determining which markets you can access and which CFDs you can trade. A reliable broker makes sure your funds are protected and all trades are executed fairly. Choose a broker that offers the following features:
- A user-friendly trading platform, such as MetaTrader 4 or MetaTrader 5
- Competitive spreads
- Responsive customer support
- Positive client reviews
Moreover, a reliable CFD broker offers educational resources, so you can polish your skills.
Leverage Works Both Ways
Traders are primarily drawn towards CFD trading due to leverage. It allows traders to control larger positions with smaller initial deposits. Instead of paying the full price of the CFD asset, traders only deposit a small percentage, known as margin.
But here’s what most traders forget: Leverage is a double-edged sword. While small market movements can lead to significant profits, they can drain your account just as quickly. If the market moves against you, losses can exceed your initial deposit. Moreover, many brokers issue a margin call, requiring the trader to deposit more funds to keep the position open.
To prevent this, choose the leverage ratio carefully and keep enough equity in your account for rainy days.
CFD Trading Comes with Costs
Another thing you should consider before trying CFD trading is the cost. First off, there is the spread, the difference between the buy (ask) price and the sell (bid) price. The spread depends on the broker and can vary due to market conditions and volatility.
Some brokers, especially those facilitating stock CFDs, charge a commission. Brokers also charge an overnight financing fee. This is charged when you hold a position overnight and can add up quickly if not carefully monitored. Other potential costs include:
- Currency conversion fees
- Account management fees
- Controlled risk premiums
Always compare the costs and services of numerous brokers to find the one that best suits your budget.
