In the UK, a CFD, or contract for difference, is a popular type of derivative product that enables traders to speculate on the rising or falling prices of fast-moving global financial markets (such as indices, commodities, currencies and shares) without having to take ownership of the underlying asset.
CFDs are available through several online brokers and trading platforms like this one here which allows users to trade from anywhere in the world. The Financial Conduct Authority (FCA) regulates CFD trading in the UK.
When trading CFDs, investors can go long (buy) if they believe the underlying asset price will rise or go short (sell) if they think it will fall. Profits or losses accrue as the underlying asset price moves up or down.
Unlike other forms of trading, CFD trading often allows traders to usse leverage, or borrowed money, to amplify their potential profits (or losses). Margin trading can help traders gain exposure to a larger market than possible with their capital. It can also magnify losses if the forex market moves against the position taken.
What are the risks of trading CFDs in the UK?
Contracts for difference are complicated financial products that often result in a loss of funds due to being highly leveraged. Studies have shown that 74-89% of retail investors will lose money when trading CFDs. Before participating in this activity, understand how it works and if you can handle the high risk involved.
The UK’s tax authority, HMRC, considers CFD trading speculative and not investing. Any profits are subject to capital gains tax (CGT). Unlike other trading options, you don’t own the fundamental asset when you trade CFDs, which is different from traditional investing. For example, if you buy shares in a UK company, you own a part of that company. With CFDs, you speculate on the underlying asset’s price movement.
If you think the UK forex or stock market will rise or fall, you can go long or short on a CFD trade. If you think the UK market will rise, buying contracts indicates you have taken a long position. If you think it will fall, you take a short position by selling contracts.
How to start trading CFDs
The first step is to find a UK-based reputable broker that offers CFD trading and ensure they are regulated by the UK’s Financial Conduct Authority (FCA). The FCA is responsible for safeguarding the financial markets and protecting consumers.
Once you’ve chosen a broker, you’ll need to open and fund a UK trading account. Some brokers also accept e-wallets, such as PayPal or Skrill. The next step is researching the markets you want to trade in and familiarising yourself with the risks involved. It’s important to remember that prices can move quickly in volatile markets, so it’s crucial to have a good understanding before you start trading.
Money management techniques for CFD traders
Proper money management is essential when trading CFDs to preserve your capital and ensure long-term profitability.
The cardinal rule of money management is to never gamble with more cash than you’re willing to part ways with and to set a hard stop-loss level for each trade and adhere to it strictly. It may also mean limiting your market exposure by only taking trades you’re confident in.
Another crucial element of effective money management is diversification. By spreading your capital across multiple trades and asset classes, you can minimise your overall risk while allowing yourself to achieve profits.
Of course, no money management strategy is complete without a sound risk-reward ratio, which refers to the potential profit you’re willing to risk for each trade. For example, if you’re only comfortable risking 1% of your capital per trade, your target profit should be at least 2%.
Finally, always remember to factor in trading costs when calculating your potential profits, which include spreads, commissions, and overnight financing charges.
The bottom line
By following these simple money management techniques, you can protect your capital while still achieving long-term profitability as a CFD trader in the UK. Novice traders in the UK are advised to use a reliable and experienced broker to ensure they get the best possible deal.