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What are CFDs and what is leveraged trading?

What are CFDs and what is leveraged trading?

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First Published: 14. August, 2022
Last Updated: 14. December, 2022
Fact-checked by Adrian Müller

What Are CFDs And What Is Leveraged Trading?

Investing in financial markets can be a complex endeavor. Understanding the various aspects of each type of investment is vital to achieving success. CFD, or contract for difference, is one unique type of investment that not many people know much about.

CFDs and leveraged trading can open up a range of opportunities for investors. They are unique, challenging, and lucrative. At the same time, they can be treacherous if investors don’t know what they are doing.

In this blog, we’ll take a closer look at what CFDs and leveraged trading are and why they have become the talk of the town in recent times. Whether you’re a beginner or a seasoned trader, this blog will undoubtedly provide valuable knowledge on CFDs and leveraged trading.

Table of Content

What Is A Contract For Difference (CFD) Trading?

Contract for Difference (CFD) trading is an innovative form of financial trading that has become increasingly popular since its introduction in the late 1990s. CFDs are leveraged instruments that allow traders to speculate on the price movements of an underlying asset without actually owning the asset itself.

In CFD trading, agreements between two parties enable the buyer to take a position on the cost of a particular asset. The CFD trader and CFD provider agree to exchange the price difference between when the contract was opened and when the contract was closed.

To explain further, if the trader with a CFD finds that the asset’s price rises, he will offer the position for sale. The net difference between the purchasing price and the selling price is added. The investor’s brokerage account would settle the net difference indicating the gain from the deals.

If the trader sees the asset’s value falling, a starting sell position might be opened. The trader has to buy an offsetting transaction to close the position. The net difference of the loss is settled in cash using their accounts.

CFD trading allows traders to speculate on the price movements of an asset without having to buy or sell the asset. This means traders can benefit from price movements without incurring the costs associated with owning an asset.

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Plus500 is a trusted global brand that offers an easy-to-use trading platform for online traders, alongside access to share trading, crypto and a thorough selection of CFDs.

79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

Such fees include brokerage fees, taxes, and storage costs. Additionally, CFD traders can use leverage to amplify their returns, which provides the potential for a significant profit.

CFD trading is available on several different assets, including stocks, indices, commodities, currencies, etc. Traders can choose the type of CFD that best suits their trading strategy and risk appetite. It is important to note that CFD trading is a highly leveraged form of trading and, as such, carries a high degree of risk.

Traders must understand the risks associated with CFD trading before they begin trading. It is also crucial to use risk management strategies when trading CFDs, such as stop-loss orders, to minimize losses.

CFD trading can be a highly profitable form of trading. With the proper knowledge and risk management strategies, CFD trading can be a great way to diversify a trader’s portfolio and potentially make profits.

What Are The Advantages Of CFD Trading?

CFD trading is unique. It’s not like traditional stock trading or other generic types of investments. It is not a sector like forex or crypto. Instead, it’s a type of investment.

CFD investment is possible in various markets. The great thing about CFD trading is that you don’t need to put the full amount at risk. Here are some advantages of CFD trading:

1. Greater Leverage

Regarding greater leverage, CFD trading allows traders to take larger positions than they could with other traditional trading methods. This means that even a tiny amount of capital can be used to open a position, enabling traders to increase their profits while keeping their capital amount to a minimum.

The small initial deposit is known as the margin. The amount depends on the size of the position, the market you are investing in, and the margin factor. This is especially beneficial for those just starting trading who don’t have much capital to invest.

2. Low Trading Cost

Another advantage of CFD trading is its low trading cost. While some fees are still associated with transactions, these are typically much lower than those associated with other types of trading.

This makes CFD trading an attractive option for those just starting with a minimal initial investment.

3. Trade In A Broad Range Of Markets

CFD trading also allows traders to trade in a broad range of markets. It is not confined to one specific sector like stock, foreign currency, cryptocurrency, etc.

The possibilities of CFD trading range from stocks and commodities to indices and foreign exchange. This makes it an excellent way for traders to diversify their portfolios and take advantage of different market conditions.

4. Profit From Diminishing Market

CFD trading can be used to benefit from diminishing markets. Traders can profit from downward movements by taking a short position in an asset.

This trading also helps keep your capital relatively safe, allowing you to take advantage of the price downturn without committing a large amount of capital.

Trading beginner - Plus500 -white

Plus500 is a trusted global brand that offers an easy-to-use trading platform for online traders, alongside access to share trading, crypto and a thorough selection of CFDs.

79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

5. Keep Your Capital

The main advantages of CFD trading are keeping your capital and gains at low risk, low transaction costs, and the ability to trade in high leverage. Unlike traditional stock trading, CFDs don’t require purchasing the underlying asset.

Instead, you can speculate on its price movement by entering into a contract with another party. This allows you to open positions with minimal capital and leverage, making achieving greater returns easier than traditional stocks.

6. Low Tax

CFD trading is also attractive to investors because of its tax benefits. In many countries, profits from CFD trading are exempt from the capital gains tax, and most countries also offer reduced tax rates on CFD profits.

This makes CFD trading an attractive option for those looking to reduce their tax liability and keep more of their profits. However, tax laws are changing all the time. So it’s advisable to consult with a tax lawyer before investing.

What Is Leverage In CFD Trading?

Leverage is a double-edged sword of CFD trading. It is a powerful tool that can amplify your returns by allowing you to trade larger positions than you would otherwise be able to with your available capital.

However, it can also be a risky strategy that can lead to significant losses if you don’t understand the risks. Simply put, leverage is the ability to control a large amount of capital using a relatively small amount of your own money.

It is an attractive option for traders because it allows them to open positions with a higher value than their account balance. For example, in CFD trading, if you want to open a position with a value of $10,000 but only have $1,000 in your account, then you could use a leverage of 10:1.

You can control the $10,000 position with only $1,000 of your own money. Leverage is expressed as a ratio, such as 10:1. The first number is the amount of money you are risking, and the second number is the amount of money you can control with that amount.

So, in the above example, the 10:1 leverage means that you are risking $1,000 to control $10,000. The higher the leverage ratio, the more risk you are taking on. This is why it is essential to understand the risks associated with using leverage and always use it responsibly.

In CFD trading, you can use leverage to your advantage if you understand how to manage your risk. However, it can also be a dangerous tool if you don’t know what you are doing. So it’s always important to have the correct knowledge and equal expertise to survive in these waters.

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79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

Benefits Of Leverage In CFD

Leverage in CFD is unique. It offers some decent benefits. If you can carefully work off of it, you can make a fortune.

To realize what CFD leverage offers, it’s important to understand its benefits thoroughly. So here are the benefits of leverage in CFD:

Big Profit Margin

Leverage provides investors with the opportunity to increase their potential return on investment. When using leverage, investors can open larger positions with a smaller deposit. Investors can take greater risks and potentially generate much higher profits.

Leverage also gives investors access to more markets and allows them to benefit from price movements in various markets.

Profit From Both Market

Investors can also short the market. This means they can benefit from falling prices and rising prices.

When the price of an asset falls, the investor makes a profit, while when the price of an asset rises, the investor loses money. Investors can gain exposure to various markets and benefit from rising and falling prices.

Available Funds For Further Investment

If a trader has limited capital, they can still control a larger position in the market. This is because leverage increases their position size, enabling them to control more of the market.

Leverage is an effective tool for traders to gain maximum exposure to the market. It enables them to control more of the market with less capital. The investor can use the remaining amount after investing in CFD for other financial ventures.

24-hour Trading

Leverage in CFDs also provides investors with 24-hour dealing. This means that investors can access their positions at any time. They can respond to market events quickly and efficiently.

This provides investors with more flexibility. It also lets them take advantage of market opportunities wherever and whenever they arise.

Trading beginner - Plus500 -white

Plus500 is a trusted global brand that offers an easy-to-use trading platform for online traders, alongside access to share trading, crypto and a thorough selection of CFDs.

79% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

Potential Risks Of Leverage In CFD

Every financial investment comes with substantial risks. CFD is no different, either. What’s unique about leverage in CFD is that it can work both ways.

It can be your saving grace or your demise. Everything depends on your knowledge, skills, and patience. Here are some significant disadvantages of leverage in CFD:

Big Loss

One of the significant drawbacks of leverage when trading CFDs is the potential for big losses. When using leverage, traders can make larger profits.

But these profits can go away just as quickly. An investor should carefully decide how much leverage they will use. Also, the investor should determine the leverage before trading.

No Shareholder Benefits

Another downside to leverage is that you can’t benefits from owning the underlying asset, unlike a shareholder.

With CFDs, you are speculating on the asset’s price, not owning it. You have no voting rights or other privileges from owning the asset. In CFD trading, unlike stocks, you won’t get any dividend payments.

Margin Calls

The possibility of margin calls is a significant disadvantage of leverage. This is when the necessary margin to cover the position increases. In such cases, the trader must top up their account with additional funds.

This can occur if the underlying asset’s price moves significantly against the position held by the trader.

Fees

There may be additional funding charges when using leverage. When you use leverage, you borrow the funds to open the whole position in exchange for your deposit.

Regarding the 24-hour trading benefit we discussed above, depending on the broker, you might have to pay a fee if you want that privilege. Such fees can eat into your profits.

Conclusion

CFDs are a form of financial trading that allows traders to speculate on the price deviation of various assets. Leveraged trading is a way to increase the potential returns of a trade by investing less capital.

If you tread carefully, CFDs and leveraged trading can be powerful tools to help traders maximize their profits. There is no alternative to learning for successful investment, so stay focused.

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About the author – D. Schmidt

I’m a German stock trader who has lived around the world. I travel extensively and believe that my experiences give me a unique perspective on global markets. I love trading! It’s always exciting to see what happens next. My goal is to help people understand the game so they too can enjoy it to the fullest. In this blog, I will share some tips and tricks that helped me along the way.

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