For those who are beginners to the trading world, a contract for difference (CFD) is an agreement that spells out an exchange that can occur when there is a difference in an asset’s value that happens over the period of when a contract is open until when it closes. The great thing about CFD trading is that if the market is favourable towards your purchase, you can monetarily benefit without actually owning the asset. CFDs open up users to over 10,000 markets to trade, many of which are not accessible for traditional or retail trading.
How Does Contract for Difference Trading Work?
The great thing about CFD trading is that you can profit on your trades regardless of whether the market moves up or down based on the position you buy. This determination takes a bit more strategy as you have to accurately predict the market in order to profit. For example, if you believe that the price of an asset is going to increase, you will want to open a buy position. If you believe that the price of an asset is going to decrease, you will want to open a sell position.The main benefit of contract for difference trading is that they are a flexible alternative to traditional stock market trading as you can profit off a falling market instead of just a rise in stock. Furthermore, while traditional brokers use a fifty percent margin, CFD trading brokers often only require a five percent margin. If we examine this feature and put it into perspective, 100 shares of a $20 stock would normally cost $2,000. A fifty percent traditional margin would require $1,000. With a CFD broker, the trade could be entered for only $100 cash outlay. What a steal!
Features of Contract for Difference Trading
Ability to Buy or Sell
Depending on whether you think the market prices of an asset with rise or fall, you can choose to buy (go long), or sell (go short). This is great for individuals who want to get quicker benefits from trading. Unfortunately, the ability to buy as well as sell does not guarantee that you will not have losses. For example, if the market moves against your prediction, your losses will also increase.
Hedge your Portfolio
Often, traders are concerned that their portfolio may lose a portion of its overall value. If this is the case, CFD trading can help offset this through short selling some of their shares. Many traders and investors use this technique in today’s market due to how volatile it has been recently.
Offset Potential Losses
While not as common to use with contract for difference trading, some individuals choose to offset their capital gains tax liabilities through using their CFD losses against them. This tax benefit is a bit more complicated and usually requires the help of an individual experienced in independent investments.
High Leverage Trading
Since you generally only pay approximately five percent of the total trade value when you open your CFD position, the leverage can help magnify how much you made on your return on investment. Unfortunately, when you experience losses, they are reflected in the same manner. There are a number of risk management tools that are available for free to help avoid potential losses, but the best route would be to seek out advice from a professional in this field.
Free from Stamp Duty (UK Only)
A great feature of CFD trading is that you can save an additional 0.5% when you trade as they are free from stamp duty. This is because you do not actually own the asset. This is true throughout the United Kingdom, except for Irish stocks. If you choose to obtain a contract for difference with these stocks, you will be charged at one percent of the trade value that is refundable as long as you do not hold onto the stock for longer than thirty days.
PLEASE NOTE: Stamp Duty savings is only a benefit for UK based traders. Companies such as CMC Markets promote this benefit to their Australian based clients but unfortunately this is not the case. Upon closer review, you’ll find an asterisk next to this ‘feature’ which is linked to a disclaimer at the bottom of the page highlighting its relevance to UK traders only.
Access to Thousands of Markets
Stocks are available in a wide range of markets, but CFD trading opens up a whole new world filled with thousands of individual shares, indices, interest rates, sectors, commodities, and currencies. This exposure to global markets can seem overwhelming at first, but it allows for a high level of monetary potential. This is often one of the prime reasons that people enjoy exploring CFD trading options versus traditional stocks.
The Best CFD Brokers In Australia
There are numerous CFD brokers available in Australia that can be found and compared through our website Compare Forex Brokers. The top five CFD brokers for 2016 include CMC Markets Australia, IC Markets, Think Forex, Pepperstone, and Go Markets. CMC Markets has been rated the best value as they do not require a minimum deposit, have guaranteed stops, are compatible with all common devices, and give users unlimited access to a free demo account. Furthermore, they provide a promotional bonus of up to $10 per million units traded over 25 million units. In terms of the highest rated broker, Think Forex and IC Markets tied although the latter had more features that users tended to navigate towards.
A Summary of CFD Trading
Overall there are a number of advantages and disadvantages of CFD trading. With lower margin requirements, an unremarkable access to global markets, and few fees, it can seem like a dream to many. There are however, a few disadvantages as well. The high leverage that CFD trading brings can also magnify losses. Furthermore the industry is not regulated well so it is important to do a lot of research before choosing a broker to ensure credibility, reputation, how long they have been in the business, and their financial position. Depending on what you want your trading plan to look like; CFD trading can be a great alternative to traditional stock trading but remember to put strategies in place to hedge your risk. It is one of the most popular derivatives to trade in Australia but remember to know your limitations and learn all the definitions and basics before you commence trading.