Pros & Cons of Dealing CFDs
Betting on Margin: CFDs allow you to hold much more value than you actually contribute. By using margins, traders are able to earn much higher return on investment percentages.
Traders never have to purchase the underlying asset: Because CFDs are simply contracts between a trader and a brokerage company, relating to the value of an underlying asset, the traders never have to have access to the actual exchange they are trading on.
No Stamp Duty: Since CFDs do not require traders to purchase any shares, stamp duty is not levied on trades.
Dividends are paid: If you hold a long CFD position on a company at the time of a dividend pay-out, your account will be credited for the amount of that dividend. CFDs are designed to mirror the value of their underlying asset, so you will receive all the benefits of actually owning the stock.
Interest is paid: If you have money tied up in a short position CFD, the brokerage firm will pay you interest on that money. If you had actually sold the stock instead of just purchasing the short CFD, you would be able to earn interest on the proceeds of the sale. Since you are not earning this interest, the CFD Broker will credit your account for the amount that you would have earned.
Ability to short shares: It is possible for traders to make money on shares that lose value if they predict the movement correctly. This is possible with many financial instruments, but CFDs make it very simple because they do not require the user to actually purchase any shares in order to sell them.
Guaranteed Stop Losses: CFDs can be very risky and traders are susceptible to very large losses if they do not cover their options properly. The best way to reduce and limit this risk is with a Guaranteed Stop Loss. This function, provided by CFD Brokers, guarantees traders that if their CFD reaches a certain percentage of loss, it will automatically close, to ensure that further losses are not incurred.
After Hour Trading: Many CFD companies permit traders to purchase CFDs even after the market for the underlying asset is closed. Private investors who work full time jobs, and invest after work, benefit the most from this feature.
Plenty of Choice: CFDs offer a wide variety of assets for investors to trade. All major stocks will be listed, as well as major indexes, commodities, currencies and sectors. Traders will be able to create a diversified portfolio of CFDs.
No Exercise Date: Unlike options, CFDs do not have an exercise date. The only time constraint that CFDs have is interest charges for trading on Margin. Options usually have a 1 month lifespan, and the investor must exercise it before the expiry date, or they will lose the option. CFDs last as long as the investor would like. The only way to terminate the CFD is by closing out the contract, and settling the difference.
Cons
Interest is Charged: CFD contracts are made on a margin. This means that the CFD broker is effectively giving the trader a loan. As with every loan, the trader must pay interest on the margin that the CFD Broker is providing. This is why CFDs are most useful on short term trades, if a CFD is held open overnight then interest will be charged to the trader.
No Voting Rights: Although CFDs mirror the value of their underlying assets, they do not mirror the ownership aspect of real shares. If ownership and voting reports are important for an trader, then CFD dealing would not be appropriate.
High Risks: When trading on a margin, the potential for risk is much more than the investment that the trader is putting forward. Since only 10% of the investment is required and the rest is supplied on margin, it is possible for traders to lose ten times what they put down. Also, if a trader shorts a stock on a CFD the potential for loss is technically unlimited.
Guaranteed Stop Loss: Even though guaranteed stop losses are very useful to limit risk, they are often expensive, and have a limited life. It is important to mind the expiry date, and monitor the amount being spent on guaranteed stop loss order, to ensure that they are beneficial.
Dividends are charged: When a short position is opened on a CFD, the trader’s account will be charged if the company issues dividends. In order to mirror the actual value of the underlying asset, the dividends must be taken into account. If the trader had actually sold the stock, instead of using the CFD, he would not receive the income from the dividend; therefore this loss in income is represented in the trader’s account.
