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CFDs are an excellent way for advanced investors to hedge against losses and maximise profits. Here’s a full introduction to this unique investment type.
Read the latest news about CFD Investment products in Singapore and the best money saving tips.
What is a CFD?
CFD refers to Contract For Difference. This is a financial instrument that allows investors to profit from increases or decreases in the prices of shares, commodities, currencies, and other assets without actually owning them. What you’re trading in this case would be a contract highlighting a specific asset’s current value and its value when said contract expires.
How do CFDs work?
At its core, CFDs are relatively simple financial instruments. After all, you’re just speculating the direction and degree to which an asset’s price will move. For every point that the price moves, you make a gain or loss multiplied by the number of units that you have purchased or sold.
CFDs also complement your existing investment portfolio by hedging against losses. For example, you can turn a profit by making a short CFD trade in Business X should you hold its shares, while believing that they will lose value soon and will take some time to recover.
Pros and cons of CFD trading
CFD: Margin and Leverage
Margin refers to a percentage of a position’s full value, concurrently reflecting how much you need in order to open said position. The position’s size (in no. of units) dictates this percentage and it can range from 10% to 50%. Leverage refers to money borrowed from the broker making up the rest of that value and allowing the trade to be executed.
CFD trading bears a higher risk compared to other investments because you have to utilise margin trading for the most part.CFDs are also speculative in nature. Furthermore, since you have not actually purchased the contract’s underlying assets, you need to determine what rights you have.
On the other hand, CFD trading gives you the opportunity to diversify your portfolio and hedge against any potential losses. You’re given access to markets across the globe and aren’t just limited to Singaporean or even Asian financial instruments.
Like Forex, you’ll need to pay the spread when trading CFDs. This refers to the difference between the bid and ask price of a CFD; it can vary from one asset to another depending on their volatility. Most brokers also charge a holding fee should you keep a position open overnight due to changing interest rates.
Because margin trading is applied when you invest in CFDs, the potential for profits is greater. However, the risk of losing all your capital is equally large if your stop-loss limit is not set properly.
Furthermore, the market moves quickly, requiring you to keep a close eye frequently throughout the day. There are occasions where you might have to intervene and maintain your margins to prevent the broker from automatically closing your position. And due to the lack of industry regulation, searching for a credible broker requires greater scrutiny.
CFD trading is fast-paced and can be applied to almost any financial instrument. Therefore, you might want to start by demo trading for several months to learn the ropes and get used to your preferred broker’s features and tools.
Take this time to determine which financial instruments you would like to trade CFDs in and see how you can weave this into your investment portfolio as a whole.