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What are CFDs? And what are the pros and cons?

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WHAT ARE CFDs?

Well, the term CFD stands for ‘contract for difference’ and they’ve become super popular over the last few years. That’s because they give people the chance to profit from movements in stock prices (and other assets) without actually buying and selling real assets.

Instead of buying the actual share, currency, bond, commodity or other asset, traders can buy contracts based on their value. The money you make is determined by the difference between the price you enter the trade and the price you exit at. So, if you buy an Apple CFD, you won’t own a share of the company, but if the real shares go up in value, so will your CFD.

HOW DO I TRADE CFDs?

First, you choose the market that you want to trade on. It’s a good idea to choose an area you understand or are interested in so you can make genuinely informed decisions.

Pick a platform you’re comfortable with and understand how it works. Some services, like BUX, offer a free demo account so you can play around for free before doing any ‘live’ trading. This helps improve your understanding before you start investing real money.

Next you decide whether you think the price of the commodity will rise or fall and buy a contract accordingly. That means you can potentially make money even if it falls in value – as long as you correctly predicted it would, of course.

WHAT ARE THE BENEFITS OF CFDs?

You need less cash to get going

Probably the biggest benefit of CFDs is that the trader needs less capital up front. For example, with shares, you have to buy each share in full. So, if a share is worth £200 and you have £500, you can only buy two shares by investing £400. If you only have £100, you can’t buy the share at all.

But with CFDs, you can stake pretty much any amount since you’re not actually buying the underlying asset. Some platforms, like BUX, allow you start trading from as little as £10.

You can trade on the biggest companies in the world

Some of the most well-known companies have pretty expensive shares. But thanks to the low financial barrier to entry, CFDs allow you to trade around the likes of Apple, Nike or Facebook (to name just three).

For example, Amazon is currently trading at around $1,975.74 per share. So, you would need a decent chunk of change to get involved.

Trading on these giant companies can make it more exciting as you are focusing on the big brands that you might know more about.

You can go global from the beginning

CFDs offer access to any market (US, European, Asian, etc) so you have a lot of options to choose from – and all from a single platform.

You can make extra money through dividends

If you’re trading CFDs in shares then although you don’t actually own them, you’re still entitled to dividend pay-outs.

You can trade on cryptocurrencies without the tech know-how

Normally, you’d need to know about the complicated technical side of trading cryptocurrency, like creating a wallet, storage and transfers, to get involved with the trade. As you don’t actually buy the cryptocurrency with CFDs, you don’t need to know all the tech stuff or worry about your digital wallet getting hacked.

It can be tax efficient

In the UK, CFDs are quite tax efficient trades as you are not required to pay Stamp Duty on the profits you make. That’s because you’re not buying anything that Stamp Duty covers, unlike stocks and shares, for example. However, you will have to pay capital gains tax if you go over your annual allowance.

WHAT ARE THE DOWNSIDES OF CFDs?

It’s higher risk

CFDs can be sold as leveraged products and this allows you to have access to a larger position if you are willing to take on more risk. In some cases, people trade with 30:1 leverage (this means that if you invest £100, you have a £3,000 position). Therefore, if the market moves the way they predicted their gains are larger. But, by the same token, their losses will also be correspondingly bigger if the market goes against them.

Like any trading market, they can be volatile

Any trading market can be volatile. Regular stocks, currencies and commodities can go up and down pretty rapidly and some can be more volatile than others. Traders often choose these markets because they think they can net big wins, and fast. However, that does also mean you can lose fast too.

CFDs are no different. It depends what market you’re buying CFDs in, of course, but the more movement you see in a market, the greater and faster-paced the reward… and the risk.
This is by no means exclusive to CFDs, but definitely something to keep in mind.

The risk of overtrading

Overtrading is when you overcommit your money and end up in real difficulties if things go wrong, which can happen even to the most experienced traders. It’s most likely to happen when people are trying to ‘get rich quick’, so it’s important to stay realistic and focused.

Some platforms have tried to dodge new regulations

When CFDs first came onto the markets there was not much regulation and it was easy for traders to lose a lot of money. Because of the way many CFDs were set up, if the market went against the trader they could end up owing more money than they initially invested – which is why overtrading was so serious. This is because their CFDs could end up being worth less than when they bought them.

Thankfully, new laws have now been brought into the UK that protect traders against this kind of risk.

However, some unscrupulous traders have simply moved offshore to avoid complying with these new rules so it is essential you choose your trading platform carefully.

Some platforms, like the BUX app for example, have had mechanisms in place to protect traders from such losses even before it was made a legal requirement.

HOW DO I STAY SAFE TRADING CFDs?

Try it for free first

Probably one of the best things you can do to understand the process of trading CFDs is to have a risk-free go. Find a platform that allows you to practice for free, meaning you can learn how it all works without loss.

For example, the BUX app allows users to start with a free demo account, so they are not at risk of losing money. That’s just common sense if you’re new to all this.

Don’t be greedy

Don’t be greedy when working out how much to trade. There are no get-rich-quick schemes in life. It’s essential to take a measured and professional attitude to your financial plans and have a robust strategy. That will allow you to make the most of the potential offered by CFDs and limit the risks.

Learn from experienced traders

Connecting with other traders can help you avoid some of the worst beginner mistakes so it’s useful for new traders to learn what they can from their more experienced peers.

With BUX you can connect and discuss market moves with other traders and see how the pros are investing their money. That can really help give you a steer as to how best to trade CFDs.

Only spend money you can afford to lose

There could be big wins on the horizon, but you could also lose all the cash you put in. Therefore, you don’t want to stake money that you need for essentials elsewhere.

If you’re interested in trading CFDs, you can try it for free and without risk with a demo account on the BUX app. When you are ready to do it for real, BUX allows you to trade a variety of products, from stocks and indices to commodities and currencies; and stay informed with daily news.

On BUX, you’ll also find a vibrant community where you can connect with fellow traders to swap tips and strategies.