Contracts for difference, or CFDs, are a type of derivative contract that allows traders to speculate on the value of an asset without having to own the asset. It makes them a popular choice for trading strategies, as they offer several benefits over other types of investment vehicles.
Key Benefits of Using CFDs as a Trading Strategy
CFD trading is typically much more tax-efficient than owning the underlying assets outright. If you hold shares in a company through a regular brokerage account, you will be liable for capital gains taxes on any profits you make when you sell them. However, if you trade CFDs instead, your earnings will be taxed at the short-term capital gains rate, the same as your ordinary income tax rate.
Australia’s current capital gains rate is 20%, whereas the short-term capital gains rate is as high as 47%. It can positively affect your overall profits, especially if you are frequently trading.
Another significant benefit of trading CFDs instead of individual stocks is that they are available with significantly reduced margins, making it easier for traders to afford the position without using most or all of their starting capital. CFD margins are average around 5-10%, while stock margins can be as high as 50%. It means that you can control a much more prominent position in a CFD than you could with the underlying stock.
Through most brokers, you can enter into a contract for the difference at any time throughout the day rather than only during regular small business hours like you would with traditional types of investments. It gives CFD traders more flexibility when making trades and prevents them from missing out on potential opportunities due to sudden market fluctuations outside regular hours.
When investing in highly volatile markets, it is often the case that a CFD trader will make more money from a volatile move during non-business hours than they would have made on a regular business day.
Unlike owning assets outright (whether through shares or other types of investment vehicles), you can generally close out a CFD position at any time without incurring any additional costs. It makes them a very flexible investment option and particularly useful for hedging purposes. Hedging with CFDs can be an effective way to protect your portfolio against sudden market moves that you may not have anticipated.
CFDs are a very liquid investment vehicle, which means that you can easily convert them into cash at any time. Traders are given the freedom to take profits when they please without waiting for an asset to be sold to receive their money. If you have enough funds in your trading account, CFDs are one of the fastest ways that you can turn a profit into cash without having to wait around and it is better than any other business online.
Long and Short Positions
CFDs also offer traders the ability to take long and short positions, giving them the potential to profit from rising and falling markets. Long positions are taken when you believe that the price of an asset will increase in value, while short positions are taken when you think that the price will fall.
Lastly, they are very flexible regarding how much leverage you can apply when trading them. By leveraging CFDs, traders can increase their potential profits (and losses) by making money from their brokerage firm. It is essential to note that leverage also increases your risk and should only be used when comfortable with the potential risks involved.
While some risks are involved with trading CFDs (like with any other type of investment), these benefits make them a desirable choice for a more sophisticated trading strategy. By understanding the benefits that CFDs offer, you can use them to your advantage to improve your overall trading results. Here is another excellent article about utilising Bollinger Bands for forex trading.
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