What was behind the surge in CFD trading last year?

CFDs, also known as contracts for difference, have seen an incredible rise in popularity over the recent years, becoming one of the most popular leveraged financial instruments available to traders. With CFDs, you can speculate on the rise or fall of asset prices, making profit on accurate predictions without actually owning any assets.

The basics of leverage in trading

CFDs make use of a trading mechanism called leverage. Leverage is used by traders to increase their exposure to the market, giving them the ability to trade without paying the full value of their position upfront. Traders only have to pay a percentage of the full value, called the margin.

If, for example, a trader was to buy £10,000 worth of assets at a 5% margin using CFDs, they would only have to pay £500 upfront, while still being able to benefit from profits calculated based on the full value. This highly increases profit potential, but also comes at a higher risk – the loss potential is bigger than in traditional trading, requiring traders to implement a proper risk management strategy. Leverage is a very popular trading mechanism in forex trading because of the market’s very high liquidity, which makes it easy to open and close large positions at will.

How do CFDs work?

Contracts for difference are a tax-efficient method of making profits on financial market speculations. They can be used for a wide variety of assets, including forex, stocks, indices, commodities, and more. These contracts, which usually are only short-term, establish an agreement between a trader and a spread betting company – at the end, both parties exchange the difference between the opening and closing positions of traded assets.

CFDs are financial derivative products that use leverage and can be also used for short selling in case you speculate prices will go down. In the United Kingdom, CFDs can be used for trading without having to pay stamp duty, as no assets exchange hands within the contract. Many traders use CFDs for hedging, reducing the risk of loss on their other positions.

What are the risks of CFDs?

While there are great many benefits to trading CFDs, there’s always the potential to lose your entire capital – and more. With traditional trading, you can only lose 100% of what you’ve paid. With CFDs and leveraged trading in general, losses can be magnified by a much larger margin. Losses can exceed the deposits – be careful when trading CFDs and always incorporate a risk management strategy to avoid overwhelming losses.

Market volatility: the reason behind CFDs’ surge

Over 2020, many global markets became unprecedentedly unstable, featuring never before seen price fluctuations. While this made traditional trading riskier and less profitable, it allowed CFD trading to boom, giving traders a tool to make a profit in a market in turmoil. Because of the margin used in CFDs, profit can be made on prices heading down, allowing traders to operate even in bear markets.

Over 550,000 traders used CFDs every month in 2020 – an increase of more than 30% over the previous year. With very low capital requirements and no direct fees for opening positions, CFDs are bringing in more and more traders each year. The emergence of so-called “meme stocks” popularized short-term trading, as platforms like Reddit and Twitter spread news about the latest market opportunities.

Online platforms make it easier to start trading at home, offering a user-friendly interface and plenty of educational materials for newcomers. This simplification of the process attracted many new traders to try contracts for difference, some of which suffered losses because of a lack of strategy. CFDs are regulated and is considered an advanced financial instrument that require patience and excellent research to make a profit on.

Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.

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