In the world of finance we can find different mechanisms designed to offer different ways of investing such as CFDs. One of the options that is gaining popularity among both novice and expert investors, as well as being an option with many benefits and points to take into account.
Also known as contracts for difference, these mechanisms allow you to invest in other underlying assets much more easily and quickly. That is why here we will tell you everything you need to know about this new way of investing and making your money grow.
➡What exactly are CFDs?
CFDs we can define them as a contract For something they are called contracts for difference, in which an institution, can be a bank or a broker, and an investor agree to exchange the difference in price of an asset. Said difference it is calculated using the asset price at the time of signing the contract and the sale price at the end of it.
In this way, the investor does not own the asset at any time, only the contract where the exchange of the difference is agreed. This makes both the leverage better and the investment lower.
By not having the asset as such, physically, the investor receives different benefits. One of them is the be able to trade with almost massive leverage , that is, make contracts with large sums of money, but with small investments. Which makes the market much more accessible.
Take into account that the final value of the asset may be lower than agreed or it may lose value, which leads to the CFD being negative. If you trade with high leverage, the risk of loss becomes very high.
➡How do CFDs work?
A leverage CFD works through a loan from the broker , which is responsible for contributing an amount of the operation. In this way we can operate without the need to put all the money in it, which makes investments accessible.
Normally, Brokers request a percentage of the CFD or guarantee contract because we must remember that the house never loses. This amount is designed to cover some type of loss, although these are also charged daily for settlements in longer-term contracts. The guarantee amount ranges from 5 to 25% of the operation plus commissions from the broker.
The guarantee normally applies to operations that close the same day . In case of not closing the operation on the day, the broker will adjust the contract to the current inter-financial financing rate. This is reflected in a new collection of new positions despite being the same in a different period of time.
We recommend that you do not deactivate the guaranteed stops, as they work as a kind of alert in case of losses. If the position incurs a loss and you do not respond to the margin call to match the required minimum deposit, the broker will close the positions.
➡The risk of CFDs
Within CFDs we can find two important risks according to experts. The first risk is high leverage which, in case the asset loses value, can translate into very high losses and debts with the broker. This is because leverage is a loan to operate.
The second risk is that the markets are very volatile So an asset that appears stable and of value today may cost nothing tomorrow. Something like this happened to oil during the 19 Covid2020 pandemic.
Before investing in CFDs you should know that there are different classes. Each of these types has special characteristics that you must take into account. Here we will tell you what each type of CFD is about.
- Financial assets: CFDs for financial assets focus on hedging these types of assets. In other words, they are contracts for difference which operate only with financial assets of a different nature. Here we find CFDs focused on assets such as: currencies, stocks, bonds, ETFs, interest rates, funds, among other options.
- Non-financial assets: On the other hand, we can find CFDs or contracts for difference focused on assets that do not belong to the financial branch. Here the options are many, although we can highlight the investment in raw materials such as metals, cereals, oil, etc. Some indices are also classified, which are usually stock markets.
➡Pros of CFDs
Trading CFDs will give you advantages such as:
- Access to world markets: One of the great advantages of this type of contract is that offers access to markets around the world. You can launch a CFD, for example, in Spanish, French, Asian markets and more.
- Guaranteed stops: This function allows you to close operations when their losses exceed the initial capital you deposited. This kind of insurance or emergency stop is designed to prevent losses from exceeding your funds which helps to reduce the high risk of CFD volatility.
- Short and long-term operations: Another great advantage of CFD is that allows you to operate both in the short and long term . You can open and close trades the same day or leave them longer to benefit from market fluctuations.
- Investment costs: Also, you should know that CFDs allow you to trade with a relatively low investment. All you need is to cover the initial cost that ranges from 5 to 25%, which allows you to operate with a very high amount of money, but with a lower investment.
➡Cons of CFDs
Finally, you should know that CFDs also have a negative side, the high volatility of the market can make your pass trade worth a lot to be worth little in moments. In addition, This can translate into big losses if you don't know how to take advantage of leverage properly.
Financial analyst and economist with a master's degree in finance.