Contracts for Difference, or CFD for short, allow traders to bet on the movement of an investment without having to own the investment. Without the cash outlay of buying a stock or FOREX currency, investors can trade with as little as $50 in markets where options cost $1000’s.
While CFD online trading is popular and offers higher profits for smaller investments, CFDs can also cause a trader to lose more money than invested.
The primary advantage of CFD trading in FOREX, as well as other markets, is the ability to profit from a small investment using heavy leverage. For example, some CFD brokers allow 2% margin for trading. This means a $200 CFD contract could profit from a $10,000 FOREX tradIt also means the $200 initial margin could be wiped out if the $10k FOREX trade goes slightly negative for the trader. Both the upside and downside of FOREX trading gets magnified with CFD margin rate.
Brokers are the middleman between clients and the financial markets in most trading. With CFD online trading, the client is perating directly with the broker and never interacts with the market. This means the broker backs the trade. A financially sound broker will honor trades, but a broker that does not have substantial reserves may find itself unable to honor trade profits. Before trading CFDs with any broker, confirm the broker has a high credit rating.
Options are similar to CFDs but much more expensive, bid on the open market, and limit losses to only the amount invested. CFDs will yield much higher profits based on the margin levels than options. Investors are, however, exposed to unlimited loss potential with CFDs, similar to with futures. Traders need to keep cash reserves to meet requirements for CFD trades that go negative, or lose money.
Unfortunately, the U.S. Securities and Exchange Commission, S.E.C., prevents supposedly free U.S. citizens from investing or trading with CFDs. Almost any other country, especially the U.K., allows traders to work with CFDs. The U.S. claims to be protecting investors, but is protecting the options industry from being dominated by CFD brokers. CFDs are more appealing because they are far cheaper to trade in than options.