Contracts for Difference or CFDs are a financial market derivative that is relatively new. However, it has risen in popularity among traders and investors due to its flexibility which allows a trader to either go long or short, while leveraging their trade and take out positions at a fraction of the cost of conventional share trading. CFDs are similar to financial spread betting in that they allow an investor to take advantage of price movements without having to own the underlying asset which spares them from the cost of stamp duty and high capital requirements.

One of the main advantages associated with CFDs is that it offers a trader the chance to speculate on instruments in the financial market without having to own them. This is because CFDs allow a trader to hedge a position in an instrument by putting forward a fraction of the share price as the margin. CFDs are leverage products which require a buyer to take out a small deposit and use it as a lever to borrow and gain access to a larger equivalent quantity of the assets. CFD providers will then hedge the position of the buyer by buying the underlying instrument. As a result, CFDs expose the buyer to more opportunities than in the circumstances of having bought the instrument.

CFDs also offer the advantage of convenience in that you can trade in one account for accessing a variety of stocks, commodities, forex and indexes. From this account, you can take out various positions in these assets, which saves you the trouble of opening a new account for every transaction you make. Different CFDs can be run from one account, giving the buyer an overview of his investments at a glance. This is pretty convenient as it saves the buyer time in having all his investments in one place. On the same breath, CFDs are straightforward agreements that can be acquired over the counter. This means that you can take out a position in an instrument and start exploiting that position right away unlike other asset trading where you have to wait for a while before you can start enjoying the full benefits of your investment.

That being said, we have to note the major disadvantages of CFD trading. Like all financial market derivatives, CFDs also have a few disadvantages that can be managed. One of the major disadvantages of CFDs is that they are leverage products which, although they expose one to potentially more products in the financial market, they also expose the risk the buyer is taking by investing in them. CFDs work by leveraging the position of the trader to gain more access to a larger quantity of assets than he would have been able to by using conventional investment methods. As such, a trader assumes more risk in CFDs because he can stand to lose the initial deposit he put up in an instant. Thankfully however, there are counter measures which can ensure that a trader’s position is guarded from this risk factor making CFD trading much safer.

Anna Edgley is the author of this article on CFD Trading. Find more information on CFD here.