What is a CFD? What is the cost of trading CFD?

EducationNovember 26, 2021

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When trading in financial markets, traders may often come across the term CFD. So what are CFDs? Should traders trade CFDs? How risky is CFD trading? The following article will help traders learn more about this term.

What are CFDs?

CFD is an English acronym of the phrase contract for difference. Contract for difference (CFD) is a derivative product that allows you to speculate on financial markets such as stocks, indices, commodities, forex… but without owning the underlying asset. When traders trade CFDs, they bet on the price movement of the support and expect to make a profit between the difference between the opening and closing prices.

The trader places a buy order. When the price increases, the trader closes the order and takes a profit. Conversely, the trader places a sell order. If the price drops, the trader closes the order and takes a profit.

What is the cost of trading CFD?

When trading CFDs, there are some fees as follows:

Spread: The first fee of any CFD transaction is the spread. Spread is the difference between the bid and ask prices. The trader enters a buy position at the bid price and closes the position at the ask price. Each broker will offer a spread for each different asset class. In addition, the spread also changes depending on the time. For example, at the time of news release, the spread is usually higher than regular times. The liquidity of each asset class also affects the spread. Highly liquid, heavily traded assets have smaller spreads.

Besides the spread, CFD trading also has a fee for holding an overnight buy position. Traders typically pay an interest fee if they hold positions overnight for leveraged trades. This fee depends on the leverage ratio traders use. The trader has to pay an overnight fee for a leveraged buy order because the broker then lends the trader money to open the position. However, if a trader holds a leveraged sell position overnight, the trader will receive this fee into the account.

In addition to the above fees, if trading stocks, some brokers also charge a commission for stock CFD transactions. However, many brokers now allow 0% commission stock trading with non-leveraged trades such as eToro and Capital.com.

What are the advantages of trading CFDs?

CFD allows both buy and sell orders

The most significant difference and advantage of CFD trading are that traders can trade CFD products in both Buy and Sell directions. If the trader sees the price going up, they enter a buy order. Conversely, if the trader believes that the price will fall, the trader enters a sell order. If the price goes in the right direction, the trade is profitable and vice versa.

The downside of trading the underlying asset is that traders can only enter the market when the market is trending up. However, with CFDs, whether the market is trending up or down, traders have the opportunity to trade profitably.

CFDs allow the use of high leverage.

In addition, when trading CFDs, traders are also allowed to use high leverage to increase trading volume with only a much smaller margin. Each broker will offer different levels of leverage. However, the lowest leverage is 2:1, and high leverage can go up to 500:1 (with Capital.com broker).

The higher the leverage, the less capital a trader uses per trade and the higher the profit potential. However, leverage is always a double-edged sword, and higher profits mean that the trader faces the same risk of loss if the trade goes in the opposite direction.

Opportunity to trade a variety of assets, different regions on one platform

Usually, CFD brokers offer a wide range of different asset classes globally. Traders can trade stocks, indices, cryptocurrencies, commodities, forex, and more on only one platform. Besides, brokers also provide assets in many different countries and regions. This makes it convenient for traders to manage all transactions.

What are some disadvantages of CFDs?

Big risk.

When it comes to CFD trading, traders often like the flexibility of this product. However, traders cannot deny the risk when trading CFDs. Trading CFDs is always risky in terms of liquidity and profit margins. If the trader predicts the wrong direction of the price, the trade loses too much due to leverage, and the broker is forced to close the position. This usually does not happen with the underlying asset investors.

Another risk when trading CFDs is that the market has too much volatility, or slippage occurs at times of big news. At that time, the stop-loss order does not close the order at the original position. This caused the trade to lose more than initially expected.

High transaction costs.

CFD traders usually trade for short periods. Continuous trading causes traders to pay spread costs for each trade many times over. These spreads can affect profits significantly.

In addition, if a CFD trader holds a leveraged overnight position, an additional swap fee may be charged to the broker.

The CFD market is not strictly regulated.

Agencies or governments do not heavily regulate the CFD market. CFD traders often trade on the platforms of reputable brokers so as not to encounter scam situations, not withdrawing money when profitable, cheating in spreads… However, choosing brokers Getting between thousands of brokers in the market with new traders is challenging and takes time to learn.

Conclusion: What is a CFD?

Above is some basic information about CFDs. Trading CFDs has a lot of advantages. It requires little capital, the opportunity to trade a variety of different assets on just one platform. Traders can trade in any rising or falling market. However, traders need to choose reputable brokers and use leverage, stop loss… in an appropriate way to control risks.

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