The art of trading comes in different shapes and sizes. Thanks to the diversity of the various financial markets, literally anyone in the world can find their preferred asset and trade it with relative success. There are currently no outlining features for each asset that potentially make it the best one to trade with. All of them come with their advantages as well as disadvantages.
In most cases, it is recommended that you have an extremely diverse portfolio, but that is usually done with different types of the same assets. For example different currency pairs, commodities and stocks. But what if we could unite all of these assets under one single class and diversify them through that? This is where CFDs come into the picture.
CFD is an abbreviation for Contracts for Difference. They are used as intermediaries for the types of assets. For example, if one were to trade a Microsoft stock CFD, they don’t actually own the stock. CFDs provide the ability to just speculate on the price within a given timeframe. So once you buy a CFD of a specific asset, you are buying the price point of that asset at that time, not the asset itself. This could be a bit confusing for beginners. But a small outline of the advantages and disadvantages are enough to make them clear.
The Advantages of CFDs
Like any other asset class, CFDs have clear advantages over other types that help them stand out within the noise of financial markets. Let’s look into the most effective ones.
Leverage is not something unique to CFDs, but they are indeed considered as an advantage compared to stocks and cryptocurrencies. Margin trading is indeed allowed on both of these asset classes, but the leverage offered is either non-existent or extremely low. With CFDs, the traders are able to use numbers like 1:100 or even 1:400.
According to Forex brokers in South Africa, most of their customers are interested in Crypto CFDs thanks to the massive popularity of the digital currencies. Unfortunately, however, the currencies themselves are not enough to satiate their ambitions of trading with high volumes. Those same Forex brokers started offering CFDs on cryptocurrencies, which was the deciding action to win over most of the local market thanks to the high leverage.
This can be seen all over the world. Europeans favoring Stock CFDs and the Americas focusing on commodities. The leverage is often the deciding factor to trade CFDs.
Lower Initial Deposit
Thanks to the leverage, most traders are able to generate significant profits even with meagre initial deposits. For example, if you want to start trading on an established stock broker’s platform, you’d need to deposit at least $5,000 initially. Now, $5,000 is not something everybody has laying around to play with, therefore stock brokers became exclusive to upper-middle-class traders.
However, CFDs do not require such large deposits. In most cases, a trader will be able to find a company that is ready to accommodate them with an initial deposit of $250, which is more attainable for the majority of the world’s population.
The Disadvantages of CFDs
Unfortunately, the advantages of CFDs end with the lower initial deposit. Although the asset class may seem extremely useful on paper, the reality is completely different. Let’s now look at the features of CFDs that scare away most traders.
Limitations in Trade
Every CFD trade has an expiration date. In most cases, these dates are 24 or 48 hours, which makes long-term trading impossible. Well, technically it is not impossible. A trader can indeed extend the deadline of the trade, but it will cost him quite a bit in fees.
Because of this feature, CFDs are usually considered to be tools for short-term trading. They’re like diamonds for scalpers and day traders. But are worth less than dirt for long-term speculators.
Not Owning the Asset
For some traders, the ownership of a specific asset is not important. However, for the majority of the people involved with Stocks, cryptocurrencies or commodities ownership is essential. The reasons are quite simple.
Cryptocurrencies are something that can be used outside of the financial markets. They can be used as a means of payment in the digital sphere. In some cases, people refuse to except anything but cryptos. A CFD trader may find him or herself at a massive disadvantage were that to occur. Furthermore, most cryptocurrencies are also considered as stocks. So for example, if a new coin comes out and you buy 25% of it, you are considered as a market-maker. Your ownership of the coin is so large that you get a seat at the investor table to propose future business plans for the company.
The former is relevant to stocks as well. Having a significant share of the company makes you an influencer. Having that seat in most cases is far more important than just having a high amount of equity through CFDs.
With commodities, it is a bit different but ultimately falls under the same reasons. For example, a gold trader may one day decide to use his assets not for trading, but for manufacturing or distribution. Having CFDs on gold prevents that as you do not own it.
As you can see, CFDs provide the ability to just trade the assets and nothing else.
Lack of Variety
When trading on a platform designed for a specific asset, you have access to pretty much all of the market. However, when trading with CFDs it is quite hard to get your hands on CFDs for exotic assets. These can be CFDs on newly IPO’d companies, new cryptocurrencies, and exotic commodities.
With cryptocurrencies, traders get about 4 to 5 options. BTC, LTC, ETH, XRP and sometimes BCH. With stocks, you’d usually find large companies like Apple, Google and etc. Commodities are also limited to Gold, Silver, Oil and etc.
So which option is better?
It is extremely hard to say which option is the best for an individual trader. As you can see there are dozens of details to consider before making a choice. But all in all a general classification can be made.
CFDs are good for day traders and scalpers, while they are useless for long-term speculators.