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What are CFDs and what is leveraged trading?

What are CFDs and what is leveraged trading?

The potential profit seems to increase, but the risk is associated and increases in terms of potential gains, especially when leverage is factored into the equation. Investors seem interested but often hesitate to even consider investing in CFDs. Therefore, this article explains what a CFD is, how it works and whether CFD trading is for you.

What is Trading with Leverage?

The possible profit seems to increase, but the risk rises concerning potential profits, especially when leverage is included in the equation. Investors seem interested but often remain hesitant about even considering investing in CFDs. Therefore, this article will cover what a CFD is, how it works, and if CFD trading is something for you.

The basics of CFDs

Contracts for differences (CFDs) are contracts between you (as an investor) and financial institutions, where investors open positions based on the future value of an asset. As the name states, there is no tangible or physical delivery of goods. With CFDs, investors can speculate on the future price of an underlying asset such as crude oil, but CFDs are also available for shares and foreign exchange. If an investor decides to buy/long a position, then the second trade is considered a sell. If the first trade is ‘short’, closing trades are buys. The profit/loss is the difference in price between the closing trade.

What are the risks of trading with a margin?

Leveraged products, used for leverage trading, are a tool that involves using borrowed money to increase the share quantity involved in a trade, creating the possibility to buy a higher amount of shares you were otherwise unable to pay for. When traders expose themselves to a more prominent position, potential losses or gains are significantly amplified. Theoretically, CFDs consist of easy concepts but remain underestimated by large majorities, as 66 to 78% of retail investor accounts turn a loss when trading CFDs. Total losses in combination with leverage pose the biggest threat for investors, making it vital to understand the ins and outs before managing a CFD portfolio. In addition, these highly leveraged portfolios have relatively detached features from other instruments. Regulatory issues also restrict traders in considering CFD trading. For example, CFDs are illegal in the US. Furthermore, CFDs are traded as an over-the-counter product (OTC), meaning trades happen directly with another party without passing through regulated exchanges. In addition, leverage trading is a sensitive topic and concerns regulators worldwide.

Should you try leveraged trading?

Leveraged trading, when applied correctly, can create enormous profits for a trader. However, it is crucial to consider that leveraged products, also known as margin trading, can result in subsequent losses in trading. The reality is that 90 percent of margin traders lose money. Furthermore, an average margin trader’s career can often crumble within weeks. With adequate knowledge and market experience only, it could be lucrative for an investor to trade solely with a margin. CFDs are products with high rewards, often eclipsing the risk involvement of counterparties, markets, client money, and liquidity. Moreover, investors must maintain margin by risking leveraged losses. However, contrary to risk, there is a significant amount of money to be made trading CFDs and experienced traders with prior knowledge and a determined strategy can succeed in this challenging market.
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