What are the benefits of CFD Trading?

[Paul B]

I have heard a lot about CFD Trading, but i am unclear about what the true benefits of this are? Apart from the increased leverage, allowing you both to win and loose a lot of money what are the reasons to trade in this way?

[SJCFDs]

Hi Paul,

I don't want to assume that you have misunderstood the concept of leverage but maybe you have missed the size of the implications it has for the average retail investor. You are correct in thinking that when it comes to institutional investors, perhaps very few would see any real benefits between chosing CFD trading over traditional cash equities or futures contracts.

But in the case of institutional investors like pension funds or investment banks, they have the spare capital to buy huge numbers of physical shares, and they do so for reasons individual to each of their investment strategies.

Using a pension fund as an example - the risk/return ratio that they find most beneficial/acceptable is one of relatively low, but safe returns. So they may well need to hold the physical shares in vast quantities as they want to receive the dividend income from those positions. After all, their clients are reaching retirement and their risk appetite is low - all they are looking for is a guaranteed pension they are able to live off. They never expect to be millionaires.

But when you are talking CFDs - you have to remember that they were only really ever aimed at the retail market - i.e. you, me and Joe Blogs on the street. The concept of leverage is not so much to enable you to both "win or lose a lot of money" - but really it is there to allow you to even enter the market in the first place.

US shares for example often trade with prices of $100 plus per share - if i want to take on a position of 5000 shares - dealing in physical i have to stump up half a million dollars!! I just dont have that kind of money lying around. But believe it or not - 5000 shares really isnt considered a big position by most.

When dealing in CFDs, you are also exempt from paying stamp duty to the government per transaction.

So, without leverage dont just think that you would be making or losing smaller quantities of money - it would be near impossible to do ANY kind or worthwhile trading.

Also, the access to CFD brokers is MUCH cheaper on the whole than daling with a physical share broker.

So to conclude - the real benefits of CFD tarding is seen only by retail investors. But that what we are.

If you have any questions or disagree with anything i have said, please let me know and i will try and clarify.

[Natalie]

I also wanted to add that with CFDs:
*you have access to all the indices in real time in one screen
* You can profit from falling and rising markets: because you are trading on the movement of the market
* The contract is not registered under the trader's name, but under the broker's name.
* They have no fixed expiry date, allowing you to close whenever you want
*You do not have to pay stamp duty

Hope that helps

[Paul B]

Thanks SJCFDs and Natalie,

that made things a lot clearer!

[forexhitman]

interesting nice thread

[collegeboy]

What about the disadvantages of CFD trading? So we can balance out the picture a bit...

[Lisa]

According to contracts-for-difference.com, these are the disadvantages of CFD trading:

* Price re-quotes and crossing the price spread with Market Makers CFD providers.
* Leverage can be a double-edged sword - it is essential to apply appropriate money-management techniques.
* Easy of access and low capital requirement can lead to over-trading.
* Long trades held of extended lengths of time attract ever-increasing interest payments. The interest charged for long positions held over large timeframes (6 months +) can reduce significantly the effectiveness of returns in many cases rendering the leverage obtained as comparable to buying a contract or share completely in the market.
* If the market moves against you, you may also need to meet a margin call where you either contribute more cash or be forced to sell down assets.

[smellyshoe]

One of the problems with finding objective descriptions of CFD trading is that most of the material is being written by brokers who are selling CFDs. They only tell you the advantages!

[davidfx]

The main disadvantage CFD trading is that it is really only profitable as a short-term investment. As time goes on the interest goes up and eventually the CFD becomes not worth keeping.

[pipstranger]

Just as in forex, you have to be really careful not to get swept away by the high leverage the brokers offer or you could really lose your shirt.