If you’ve ever thought about having a go at trading in stock markets – look before you leap. It goes without saying that this can be very dangerous territory and all the official warnings about not investing more than you can afford to lose should be well heeded. At the same time, this is something that can be highly lucrative when you do get it right – and CFDs or “contacts for difference” can be a way of magnifying those gains.
A CFD is a way of speculating on the price movement of an underlying financial instrument – like a company’s share price, for example. With a CFD, you have an agreement with a provider like Tradefair based on the price you enter the trade and the price at which you exit – and you make or lose money in that process. You’re speculating on the way you think the underlying price will move – but you’re speculating on the margin only and you don’t have ownership of the underlying asset.
CFDs have several advantages in that you can put up a relatively small amount of money to open a far larger position, effectively, in the company’s shares or whatever else the underlying asset may be – and you don’t have to pay any stamp duty. Of course – the margin can also work against you, so it’s important that you get to fully understand the ways this kind of trade works, the risks – and ways of minimising your exposure. There are many ways you can do this including stop-losses. The afore-mentioned Tradefair also lets you trade indefinitely in demo-mode. This is an excellent way to get to understand how the trading platform works and, specifically, how CFDs work.
Here’s an example of how it could work. Let’s say a share has an ask price of £25. If 100 shares are bought at this price, the cost is £2,500. With a CFD broker like Tradefair, you’d usually only need a 5% margin – so you can make the same trade, effectively, as buying those shares for an outlay of £125. If the share’s bid price then rose to £27.50, the shares could be sold for a £250 profit. When the share’s bid price is £27.50, the CFD bid price may be around £27, but the gain on the CFD, therefore, is 60% – compared with the shares’ gain of just 10%.
So you can see from this quick example that CFDs are excellent for magnifying gains. Remember, too, that you can use them to go the other way – speculating that the underlying price of an asset may fall. This is a way of “shorting”.
Obviously – the downside risk is that losses are also magnified when the market doesn’t move in the way you thought it would. The trick is in minimising your exposure to losses and there are various ways of doing this explained on the Tradefair site – and in getting more trades right than you do wrong. If you can do this, you won’t win them all, but you will come out ahead.