Are CFD’s good trading vehicles for new traders?
In response to the post I wrote on whether forex is the best market for new traders, I received the following question from a reader:
Hello John,
I was reading your latest post Forex is the easiest market for new traders, right? I was thinking maybe CFD might also be a good candidate for new traders too.
What do you think?
Regards
Eddie
If you’re not familiar with CFDs, let me try to dish out some basic education, though I’m no expert myself. My main reference for this discussion is the Trade2Win Traderpedia entry on the subject.
A CFD is a Contract for Difference. They are not vehicles which US traders can trade (at least not locally), but can be utilized by traders in a number of other countries, in particular the U.K. In that regard, they do offer some advantages, especially in terms of transaction costs savings as there is no stamp tax as their would be for trading exchange listed securities.
According to the Traderpedia entry, CFDs offer the following advantages:
- Margin – CFDs are traded on margin so you can maximise your trading capital.
- Stamp duty – No stamp duty is payable (saving 0.5% compared to a traditional share purchase).
- Short trades – You can profit from falling or rising markets by trading long or short.
- Diversity – A single account can give you access to far greater range of financial markets.
- Money management – You can limit & manage your risk using stop losses and limit orders.
- Regulation – CFDs are regulated in the UK by the Financial Services Authority (FSA) in accordance with the Financial Services and Markets Act 2000. All CFD transactions are reported daily to the FSA and regulated firms must have sufficient financial resources to support the volume of their CFD trading at all times.
- Dividends – Depending on your CFD broker you may be entitled to receive any dividends with the CFD you trade. This will apply if you qualify under the periods set by the underlying stock.
Being a US based trader, I’ve never traded CFDs. From what I know of them, though, they are basically like cash delivery futures. By that I mean the trader gains or loses based on the change in price of the contract, with that being credited/debited to their account, but there would never be any kind of physical delivery of shares, bonds, gold, or anything like that.
I encourage others with more knowledge and experience on the subject to chime in, but to answer Eddie’s question, I wouldn’t actually say that CFDs represent a different market, like the stocks vs. forex question. They are just a vehicle by which one can trade a market, like with forex where one could trade either spot or futures (or options, or spreadbet, etc.). From that perspective, it’s a question of picking the right market to trade, then picking the best trading vehicle. For some traders, newbies included, that is going to be CFDs.
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