What are the Advantages of Trading CFDs?
Contracts for Difference, or CFDs, are one of the best options for speculative traders in New Zealand. They allow you to enter an agreement with someone to exchange the difference in the price of an asset, from the point of contract opening to when it is closed.
As a result, you can make quite a bit of money if you happen to bet on an asset which will see its price grow or drop significantly after a certain period.
Of course, this requires a deep understanding of how the market moves, and why the prices react in a way they do. Trading CFDs in New Zealand — or anywhere else, for that matter — is easy from a technical standpoint.
However, there is still a lot of complexity to this market, and you need to study it carefully before engaging.
Despite this, traders seem to love CFD trading due to a number of benefits that it brings, which is what we will talk about today. By the time you finish reading this, you will understand why some people prefer going for CFDs, rather than other types of trading instruments.
What are CFDs and how do they work?
CFD trading is a form of derivatives trading. That means that CFDs do not have their own price, and are not considered assets, themselves. Instead, they deal on prices derived from something else — an underlying asset, or market.
These underlying assets can include anything, from shares, precious metals, energy, indices, and even currency. In theory, anything that has its own price, and that price is volatile due to changes in supply and demand or other reasons, can be used as an underlying asset for CFDs.
CFDs would then track the asset's price movements, and let you trade on live market prices. Note that you would not actually purchase or own the assets themselves. You would simply bet on their price movements, and profit if the price moves in the way you predicted.
CFDs are popular because they give people the freedom to trade global markets, and not have to put up the full value of their position. This is due to the fact that they are a leveraged product. As such, they allow traders to earn larger amounts of money with a relatively small initial capital. However, it is also worth noting that higher rewards also come with higher risks, and it is entirely possible to lose all the money by making a wrong call.
But, you do have some room to guess, and CFDs are flexible, in a way that allows you to profit regardless of which way the asset's price goes. In other words, you can bet that the price will go up or down, and if you are right, you profit. On the other hand, trading assets directly only allows you to profit if you buy them at a low price and sell them when the price goes up, which comes with significantly less flexibility, and limits your options.
Of course, for most trading endeavors, you will need to open an account with a broker that will handle your trades for you. New Zealand-based traders can choose from a variety of brokers, such as Rockfort Markets, or others. The main thing is to ensure that the broker is regulated and licensed, in order to ensure the safety of your investment, and avoid scammers. The Financial Markets Authority (FMA) of New Zealand keep an up-to-date list of these brokers here.
With all of that out of the way, let's talk about the benefits of trading CFDs in greater detail, and see why do people prefer this type of trading.
Advantages and benefits of trading CFDs
Let's start with leverage, the ability to increase your profits while still entering the trade with only a fraction of the capital you would actually need, in order to perform large trades.
Leverages are well-known in the trading industry, and they are not only used in CFD trading. Still, they can be highly useful to experienced traders who understand the market, as well as the risks that come with it.
Basically, CFDs enable your investment capital to increase while you only use a fraction of your own money. This small fraction of your deposit is called margin.
The size of your deposit will vary, depending on the size of the position, as well as the market's margin factor. However, do remember that the total profit or loss will be based on your position's full size, and not only on the deposit.
As mentioned earlier, CFD trading is more flexible than some other forms of trading. This is due to the fact that CFD trade is based on the agreement to exchange the difference between the price of an underlying asset at two different points in time — the one it has when you open a position, and the one it has when you close it.
With that in mind, CFDs on dealing platforms have two prices — the buy price and the selling price. Traders choose the buy price when they expect the market price to go up in the future. This is called going long, and it is similar to most forms of trading.
However, it is also possible to go short or choose the selling price. This is the price that traders choose when they expect that the price of the underlying asset will drop in the future.
In other words, CFD traders don't really have to care how the price is going to behave, as long as they can predict its movement in regard to the price the asset has at the time when they are entering the position.
3) You don't own the asset
We also mentioned that traders do not actually purchase the underlying asset when they trade CFDs. Instead, they only make a prediction on which way the asset's price will go.
This comes with some obvious benefits, such as not having to worry about storing the asset. Without the need to store it, you don't have to rent warehouses and similar storage spaces, which means that you are left with more money for trading itself.
4) No fees
Another major benefit of CFD trading is that you don't have to worry about extra fees. Most CFD brokers offer relatively the same order types as traditional brokers. Things such as stops or limits and more are all present as part of the CFD brokers' offer.
Now, brokers usually make money when traders pay the spread, and the large majority of them do not have to charge commissions or fees. Traders simply pay the asking price if they wish to go long, or bid price if they want to go short.
Some brokers might also offer guaranteed stops for a fee, but that varies from service to service, and it is optional.
5) Good risk management options
Whenever you enter a trade, there is a chance that things will not go the way you expect them to. Whether it is due to a geopolitical event, new development regarding the company, or even the asset itself — it is possible that the price of the underlying asset will go in a direction that doesn't suit you.
If this happens, you are likely to see major losses, unless you have proper risk management. Fortunately, CFD trading does come with those, and you can place Take Profit or Stop Loss orders, that will immediately exit your position should the price reach a certain, pre-determined level.
This will happen regardless of whether or not you are looking at your trades at the moment when the price moves. You can even go beyond that, and set Limit and Stop Entry orders, which will help you enter the market at the desired price level.
There are numerous risk management tools that will help you limit risks and lose only a small amount if the price moves in an unfavorable way, as opposed to losing the majority of your investment unless you stand guard at all times.
6) Global market access in one place
Another advantage of CFD trading is the fact that CFD markets exist all over the world. At the same time, many CFD brokers offer access to products in all, or at least most of those major markets.
This allows you to access them at any given time, and choose whatever underlying asset you wish to trade. With a diverse enough portfolio, you could be making a profit around the clock, which is extremely flexible and beneficial to any trader.
You will not be limited by the time of day, or the location, which is quite beneficial for traders from New Zealand.
7) No minimum requirements for day trading
When you wish to trade in certain markets, you might encounter some requirements for day trading, such as the minimum amount of capital, place limits on a number of day trades that you can make, and alike.
Obviously, this can be quite limiting for people who have a limited amount of money to spare for their trades, as well as for those who like to diversify their trades a lot.
However, this is not a problem that you will encounter in the CFD markets. There are no restrictions of this kind, and you can day trade as much as you wish, as many times as you wish.
You will need some capital in order to open an account, but you can do it for as little as $1,000. It should be noted that there are minimum deposits for accounts, which can sometimes be a bit higher than that, such as $2,000 or even $5,000. This is not uncommon.
However, once you go through that, the rest is up to you, and you can choose pretty much any amount or any number of trades per day in order to satisfy your trading style to the letter.
8) No expiration date
Another great thing about CFDs is that they don't depreciate in value as time goes by, unlike many other investment instruments. In addition to that, they don't come at the set expiration date, which further increases the flexibility of trading CFDs.
You can take as much time as you want and be as patient as you wish when taking long positions. If you are sure that the price of the underlying asset will rise eventually, you can simply enter a position and wait for it to happen.
While we already mentioned that day trading is a possibility, and there are hardly any limits that you need to keep in mind when entering day trades, the fact is that day trading is not as beneficial as long-term approaches in this regard. But, you can still benefit from trading with leverage, provided that you make the right move and handle the risks adequately.
Trading CFDs comes with numerous benefits, and here, we have listed some of the major ones that every trader should know about before starting. There are countless opportunities for you to take, and you have a great selection of underlying assets, risk management tools, you can day trade or invest long-term, you can trade with or without leverage, and you can use as much or as little money as you wish.
You can also trade around the clock, benefit from low to no fees, and since you don't actually buy the assets, you don't have to purchase storage areas, pay for shipping, or anything of the sort. Simply benefit from the assets' prices and make the best of any trade. You still have to dedicate quite a bit of time to learn the ways of the market, but once that is done, you will be ready to earn all the money that CFD trading has to offer.
Author: Ali Raza - A journalist, with experience in web journalism and marketing. Ali holds a master's degree in finance and writes extensively about the financial markets and fin-tech industries.