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Advantages and Risks of CFD Trading

A CFD is traded like a stock. You buy it, and when the prices increase, you simply sell it and earn a profit. However, upon closer examination, a CFD is basically a contract between any two parties that fluctuates in value over time. Whether you will earn a profit or incur a loss, it all depends on the price of the underlying asset.

There are both advantages and risks associated with CFD trading. In this article, we will discuss all of them in detail.

Advantages of CFD Trading?

1.      Lower Transaction Costs

Unlike traditional stocks, CFD trading has lower transaction costs. In these trades, you do not have to pay any commission to the brokers. Moreover, if you trade frequently, you can also benefit from the scalable and low-cost nature of CFDs. This will save you a lot of money in the long run, maximising your overall profit.

2.      Short Selling

Traditional stocks allow you to only benefit from rising prices, but in CFD trading, you can also earn a profit on falling prices by going short on a CFD. This is the best way to execute successful trades without incurring any loss.

3.      Leverage

You can significantly increase your purchasing power by trading CFDs on leverage. This is a wise approach to gain full market exposure by putting only a fraction of your trade’s full value at risk.

4.      Hedge Against Market Movements

Some unexpected adverse market movements can affect your profit. CFD trading allows you to hedge your existing investments against these potential losses. But before entering this diverse market, it is essential to understand what is CFD trading and how you can benefit from it.

Risks Associated with CFD Trading

1.      Liquidity Risks

When you trade in the less liquid markets, a wider spread can occur. This makes it difficult for you to enter or exit the position without incurring additional costs. Due to insufficient market activity, you are unable to execute trades at the desired place.

2.      Gapping

Sometimes, the price of a CFD security opens higher or lower than its previous closing price, and this makes a visible gap on the price chart. However, to minimize potential risks, you can employ effective gapping strategies and capitalize on your price volatility with these gaps.

3.      Overnight Financing Costs

If you hold a CFD position overnight, you may incur additional costs. This can significantly reduce your profit. Therefore, in CFD trading, it is essential to consider overnight financing charges to make informed decisions. You can see them on your account. They are usually displayed as a separate transaction, but do not affect your portfolio. However, if you want detailed information about the overnight financing costs, consider going through your trading platform’s statement or account history.

4.      Market Risks

The value of CFD can change rapidly, which is a major reason behind many potential losses. When the price moves against your positions, you incur a costly loss. Therefore, be careful and make smaller initial investments in larger positions.

 

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