A contract for difference (CFD) allows you to trade a stock, index, crypto, or commodity without owning it. When you trade a CFD, you simply make (or lose) the difference between the price you bought it at and the price you sell it at.
Why have CFDs quickly become one of the preferred ways for investors in the financial markets to trade?
For the savvy trader, CFDs can be used as outside-the-box solutions for several common trading problems. They can also be used to implement more advanced strategies.
One of the less appreciated benefits of using CFDs is that they allow you to trade at a smaller size.
Why is this so helpful?
On top of the ability to trade on a smaller account in general, it also allows you to be much more accurate in your position sizing. This benefits you no matter what size you are trading.
For example, if you trade the S&P500 e-mini futures contract, the contract trades in $50 increments. In contrast, the CFD trades in $1 increments. The smaller contract size provides you with much more risk control than its larger cousin.
The smaller position size also has the great benefit of allowing you to scale out of your positions. The small minimum position size allows you to split your trade into several positions. Optimally, you would split the trade into three positions rather than one and close them at separate points.
This method allows you to take some profit when the market makes it available. You can take some profit the moment you can, take more at your target, and leave some skin in the game for a big win.
Think the market is going to head down, but do not want to sell your stocks? Going “short” on a CFD index might be just the thing for you.
By shorting a CFD, you benefit as the price of the index goes down. Of course, you lose when the index goes up. The profits in the CFD can thus offset some or all of the associated losses in your stock holdings.
CFDs provide you with access to global markets that trade 24 hours a day, excepting weekends. The beauty of this is that you can fit your trading into your schedule. Have a day job? No sweat. You can choose a market that is active during your evening.
For example, if you are Australian-based, you could look to trade the UK market index (FTSE100), which is active after you finish work for the day.
Making sure your trading fits nicely into your schedule is very important. If you do not balance your lifestyle with your trading, you will find it difficult to trade consistently.
Depending on your location, CFDs can be tax efficient. If you lose when trading with CFDs, they are generally tax-deductible. This means you can offset your losses against your income to reduce your tax obligation. You can even receive a refund under certain circumstances.
Of course, you do not want to trade to lose in order to gain the tax benefits. However, even the best traders do not win all the time. Saving some money in taxes when things are not going so well is a nice little perk.
Trading is risky. T&Cs apply.