Trending into the world of financial investments is both a risky and an exciting endeavor. While many have made astonishing fortunes trading, not all have had that luck. The difference comes down to the investment choice a trader settles for and their level of understanding of the same.
You must find the most suitable investment if you plan on maintaining a gainful portfolio. CFDs are growing in popularity amongst experienced traders. They are used in the speculation of the financial market’s moving prices without necessarily owning shares. So, why have CFDs grown in popularity?
CFDs Advantages
1. Leverage
Leverage is the investment model that gives you exposure to a more significant financial market position without having 100% trade value. You can think of leverage as a lever that magnifies input force to a more prominent output source. When you look at it from an investments perspective, leverage helps increase their purchasing power by giving a full trade margin to gain exposure to underlying assets.
For example, having a 10:1 leverage ratio, one-tenth of a transaction’s size, is the required margin. Therefore, to get an exposure of SGD10,000, you will need an SGD1,000 margin.
2. Access to diverse asset classes/global markets
Using CFD makes it possible for you to speculate on various global securities and markets, from stock indices, options, forex, commodities, and cryptocurrency. This gives you exposure to different markets worldwide and a more considerable range of financial and assets instruments. This in itself makes for a diversified and well-balanced portfolio. Your risks will be lowered significantly because you won’t have placed all your eggs in one basket. Another significant benefit is the ability to trade round-the-clock since you have access to different markets.
3. Positioning and opportunities
With conventional share trading, potential profit can only be made when an asset’s price goes up. So, what will happen in a downtrend and many stocks are in mayhem? CFDs offer prospective profit when the markets are falling and rising. This is because you will be able to speculate the movement of price in any direction. If the market is moving in favor of you, there’s a likelihood that you’ll make a gain.
For example, if you notice that shares have been overvalued and prices will go down, utilize CFDs to benefit from a share price fall.
CFDs Disadvantages
1. Leverage
Leverage is a double-edged sword as it can work against or for you. With magnified potential profits, there’s also the possibility of incurring potential losses. You will gain losses when/if a market goes against your predictions.
2. No ownership
Lack of actual asset ownership is also a drawback as far as CFD trading goes. Although CFD holders gain from corporate actions like dividends, they lack voting rights in that company. This makes CFD less robust for prospective stakeholders.
3. Overnight financing
Trades that have been held overnight are subject to diurnal interest fees. When you trade CFD, leverage is in use. As such, when your trade position is held past the day’s cut-off time, your account will incur a charge.
How risky are CFDs?
It is never fun to bring up the topic of risks involved. However, it is essential to be aware of all impending risks before committing capital. CFDs are considered to be high-risk owing to their leverage nature. For this reason, new investors need to understand potential risks and find ways of effectively mitigating them.
CFD trader’s primary concern is leverage. Leverage’s gearing nature can help boost profits while losses might go beyond the initial deposit. Other risks that should also be considered include execution risks, liquidity risks, and market risks. They could cause unexpected losses if they are not adequately managed.
You can mitigate leverage with stop-loss orders. Even so, it is not guaranteed that loss won’t be experienced, more so if market movements experience sharp changes. For example, the 2020 Coronavirus pandemic shocked the financial market, and there was widespread uncertainty. Many traders did not manage to manage risks effectively with leverage, and this gained heavy losses.
Conclusion
CFDs, as hedging tools, make an excellent addition to your portfolio. Just make sure that your trading strategies, risk appetite, and investing goals are aligned. That way, you’ll be able to get the most from CFDs trading.
