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What are CFDs?
Contracts for difference (CFDs) allow investors to gain profits through price changes on various assets including stocks, commodities, market indices and cryptocurrencies. You can also trade CFDs on currencies, but in India, we typically refer to this as forex trading.
Instead of owning the asset itself, investors own a trading contract, meaning CFD traders can both profit and lose money regardless of whether prices are going up or down. For that reason, CFD trading often becomes more popular during times of market volatility, as traders seek to profit by “shorting” the market when it falls.
CFDs can be profitable, but they are highly risky and complex, with stats suggesting that as high as 8 in 10 investors lose money when CFD trading. This means that CFDs are better suited to more experienced traders.
This guide offers a complete overview of CFDs, including how they are traded, some trading strategies and what risks are involved.
5 reasons to trade CFDs
There are a few main reasons you might want to trade CFDs in India:
- CFDs allow you to speculate on thousands of financial products and global markets that you may otherwise be unable to access.
- You can go long or short, hence you can profit (and also lose money) in both rising and falling markets.
- You can hedge your portfolio. Hedging acts as insurance for the rest of your portfolio through CFDs.
- You can usually access free demo accounts, as well as charts and trading tools through your broker.
- CFD contracts don’t necessarily have a fixed expiry date, meaning you can close out your position when you decide.
What can you trade with CFDs?
If you want to trade CFDs in India, you need to fully understand how the CFD itself works as well as the underlying asset. If you have no experience trading shares, for example, it’s probably not a good idea to buy a shares CFD.
What are the risks?
CFDs are extremely risky, complex products and are ideally only suited to very experienced financial traders. Here are some of the potential risks that you should know about before deciding if CFD trading is right for you.
- CFDs are complex. CFDs are very intricate and confusing products. Even if you have a general understanding of what a CFD is, this doesn’t mean you’re ready to start trading CFDs.
- You can lose more than your initial capital. If you gamble on the pokies, the most money you can lose is the amount you put into the pokie machine. This is not the case with CFDs. If you lose a CFD trade, you can lose much more money than you started with, meaning you actually owe the CFD provider money, sometimes hundreds of thousands of dollars.
- You don’t own the underlying asset. When trading CFDs, all you own is the contract between you and the CFD provider. Therefore, you can’t benefit from the capital growth of the underlying asset over the long term.
- CFDs depend on how the market performs. Even though you don’t own the underlying asset, CFDs are still affected by market conditions. This can increase risks even more in a volatile market.
Are CFDs right for you?
Due to the complexity and high level of risk involved, CFDs will not be suitable for the vast majority of traders in India. CFDs could be right for you in the following situations:
- You are an experienced trader.
- You have a strong understanding of not only CFDs but many financial products and markets.
- You possess a high tolerance to risk and are not at all risk-averse.
- You can afford to lose quite a bit of money (it’s not guaranteed that you will, but you need to be able to afford it if you do).
- You have some level of legal expertise to understand the complexity of CFDs.
- You are not interested in owning the underlying assets.
- You understand the measures available to minimise your risk and are experienced using these tools, for example, stop-loss orders.
- You have conducted plenty of research – trading CFDs is not a decision that should be taken lightly.
How to choose the best CFD trading platform
The CFD broker you choose will depend on your trading style and what instruments or assets you prefer to use.
If you’re looking for the best online platform or app for you in India, consider the following:
- Available markets. Does the broker offer forex, gold, silver, cryptocurrency, stock market indices, and global stock CFDs?
- Direct share CFDs. Not all brokers offer CFD trading on shares, and those that do can charge an additional subscription fee to access them.
- Currencies. If you’re looking to trade forex, check whether your preferred pairings are being offered.
- Commission fees. There’s often a brokerage fee charged when trading stock and stock index CFDs, check to make sure it’s not too high.
- Live data. Does it charge a fee to access live stock market data from Indian and global stock market indices?
- Minimum opening balance. Some brokers require a high minimum opening balance before you start trading – consider trialling the demo version first if it has one.
- Platforms and software. Which trading platforms do they offer and can you add on software or analytics tools?
- Other types of trading. Do you also want to invest directly in shares, ETFs, forex or managed funds?
Frequently asked questions about CFDs
- Ask or ask price. This is the price at which a CFD trader can open a sell position or close a buy position.
- Bid or bid price. This is the price at which a CFD trader can open a buy position or close a sell position.
- CFD (contract for difference). This is a contract entered into by 2 parties who agree to exchange money according to the change in the value of an underlying asset.
- Contract currency. This is the currency in which a particular asset is traded.
- Dealing. Dealing is when you open or close a CFD position.
- Derivative. This is a financial instrument whose price is derived from an underlying asset.
- Going long. This is when you open a buy position.
- Going short. This is when you open a sell position.
- Hedging. This is taking an opposite position to reduce the risk associated with an initial position.
- Initial margin. This is the minimum initial amount of money a CFD trader must outlay to open a position.
- Leverage. Leverage allows you to trade a larger value asset than the worth of your initial investment. This is sometimes also referred to as gearing.
- Open interest. This is the interest rate that applies to all CFD positions that are held open overnight.
- Stop-loss. A stop-loss order can be placed when a CFD position is opened and is triggered when the price reaches a specified level. These orders are used to close out positions that have resulted in a loss and aim to prevent further loss.
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