CFD online trades add potential for increasing income

CFD online trading is of the more recently added trading options, with its beginnings in the 1990's. Originally it was started as a way to dodge the United Kingdom Tax of Stamp Duty that remained on securities.

CFD onlineA contract for difference---CFD---avoided this tax since it wasn't an exchange of actual stock and was considered a swap. The CFD required a minimal amount to trade on margin and was used heavily by hedge funds until it exploded in popularity with CFD online trading.

What is CFD online trading?

CFD online trading is when you invest in either a long or short position. If your belief is that the price of the underlying security, whether it's stock, Forex, market indices or energy contracts, is going to drop, you enter into a CFD contract and sell short. At the end of the day if the price drops, you made money. If it rises, you owe money. A long contract is just the opposite. If the price rises, you made money and if it drops at the end of the day, you lose. 

What makes it so unique is that it's more like betting on the price of the underlying security. You don't actually buy it. Instead, you purchase it on margin, which may require three to five percent of the cost of the actual security. If you bought ABC stock for $100 per share, 100 shares would cost $10,000. A CFD for 100 shares would cost $1,000 at 10 percent and $500 at 5 percent. The margin requirements are normally better than they would be for stocks or the same.

How is a CFD different from buying stock on a margin?

The initial difference is that you own the stock when you purchase on a margin. When you buy a CFD, you never own the stock. The contract is between you and the broker and is based on the movement of the underlying security. You are borrowing on the stock or assets you already own when you purchase on a margin. Purchasing a CFD requires no other assets.

You're purchasing the stock or another asset when buying on a margin. When you use a CFD as your vehicle, you are simply making an agreement with a broker. That makes them relatively illiquid. Your broker may pair your contract with one that another client has taken the opposite position. However, if there are no other clients for that particular investment, the broker then becomes your counterpart. 

Since the broker sets the pricing and spread, that could leave you at a disadvantage, particularly if you have less than a reputable broker. That's one reason it's important to find brokerages with excellent reputations when trading CFD online.

How is a CFD different from buying stock on a margin?

Since the broker sets the pricing and spread, that could leave you at a disadvantage, particularly if you have less than a reputable broker. That's one reason it's important to find brokerages with excellent reputations when trading CFD online.

The strategies used are slightly different than those used in the underlying investment, so be prepared for a few losses if you haven't done your homework or had a practice account. The final problem is that CFD’s are not available to everyone. People in the US can't trade a CFD online or otherwise. Canadian and Australian citizens can only trade CFD’s for indices and commodities, not individual stock.

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