Owning traditional stocks, commonly called equities, and trading them via a bank or broker is one of the most common ways that people engage in the buying and selling of investment-grade securities. The system has been around for more than a hundred years and will probably never go away because, as some say, that’s just the way it’s always been done. However, CFD trading (contract for difference) is a method that’s gaining ground very quickly among market enthusiasts who prefer a derivatives-type instrument that cuts through a lot of the red tape, fees, and headaches of the traditional way of doing business.
What’s the main attraction of CFDs? Though there are dozens of reasons people flock to them, is that there’s no need to purchase the actual shares. Instead, participants who opt for this approach use contracts that represent the ability to sell a price-tracking contract based on the underlying stock. But, there’s more to it than that. A closer look at the pertinent advantages of CFDs over broker and/or bank-based methods will uncover some of the reasons this more streamlined strategy is preferred by many people all over the world.
Advantages of Using CFDs Instead of Traditional Banks and Brokers
It’s mainly about avoiding red tape, commissions, fees, and low amounts of leverage, but there are other reasons why people prefer contracts for difference as opposed to going through a broker or bank to buy and sell financial instruments. Here are some of the most mentioned factors based on what everyday trading enthusiasts say:
- There’s total transparency: You are able to see every detail of the process as it moves along, from prices and stages of the trade, to your potential profit if you were to exit at any given time. There is never any guesswork or wondering about how profitable a particular deal might be.
- Limitation of risk: It’s possible to limit the amount of risk you’re exposed to by placing specific types of orders that close out at precise price points. Platforms for Forex traders, for example, offer a wide range of risk limitation tools to all users.
- Leverage: By far, this is one of the top advantages of contract for difference strategies. Users in the traditional stock market typically need at least 50 percent margin to make a deal. In other words, if they want to buy $2,000 of a security, they must have at least $1,000 in their account. For CFD users, margin requirements are much lower, usually in the 1 percent to 20 percent range. Thus, when using a CFD, if your margin requirement was 10 percent, you’d only need to have 10 percent of the total purchase price of the deal in your account. The bottom line is that leverage is a major factor in bringing people into the contract for difference universe.
- The chance to profit in up or down markets: The word difference in the acronym CFD says it all. Making a profit is not about prices of underlying securities going up; it’s about the prices changing in any direction you predict. In some ways, this approach is akin to shorting, but it allows either direction, going short or going long.
- Product choice: Active traders can stick with their preferred instruments, including Forex pairs, stocks, equities, or equities. It’s a misconception that contracts for difference are only a foreign exchange tool. Many traders use them to make profits on changes in indices, company shares, and more.
- Global trading: While broker-based or bank-based traditional trading of stocks is typically confined to one or two countries or exchanges, that is not the case with CFDs. Trading can take place on virtually any world market.
- No fees: When you use a CFD, the money the transacting broker makes comes from the ask-bid spread and is clear from the moment you place the trade. There are never any surprise charges or hidden fees, regardless of the kind or order you place or the value of your order. When purchasing difference contracts, people generally study the bid-ask spread very carefully and take it into account when calculating their potential profit or loss.
- No shorting rules: Traditional brokers often have very strict rules for shorting and day trading. There are no such restrictions with CFD trading. There are several reasons for this, but the main one is that when you own a contract for difference, you don’t own the underlying asset itself. Thus, all the laws and regulations that apply to selling short and day trading have no effect on your contract trade.