CFD Trading is the most popular way of leveraged investing because it allows the investor to obtain higher profits with a lower capital. When dealing with CFD's the traders must provide only for the margin requirements of their trades, while the broker will provide the leverage needed to trade larger amounts.
Let's consider for example that you want to buy Barclays stock which trades for 2.50 GBP and you have a capital of 1,000 GBP. With a standard broker that doesn't allow CFD's you would only be able to buy 400 shares at Barclays. If the share price would increase by 20% to 3.00 GBP per share your portfolio of 400 shares would be valued at 1,200 GBP. This would result in a gross profit of 200 pounds.
Now let's see how CFDs could work on your behalf in the above situation. With a capital of 1,000 pounds and a leverage of 1:20 you would be able to buy a Contract For Difference on Barclays worth 20,000 GBP. That's 20 times your capital! How is this possible? It's very simple. The broker will credit you with the entire amount of 20,000 pounds requiring you to cover only the potential depreciation of your asset. Your 1,000 capital will be held as margin requirement in the eventuality that Barclays shares would drop.
In our example, where Barclays shares gained 20% going up from 2.5 to 3 GBP your contract for difference would generate a huge profit. Instead of owning only 400 shares worth 1,000 you would have a contract on 8,000 shares taking advantage of the growth of a larger asset. When 8,000 shares are up 0.5 pounds each it will result in a whooping profit of 4,000 pounds. Going back to your initial capital of one thousand you will notice that your actual ROI was 400% instead of only 20% from the conventional share trading.
Trading CFDs can be much more profitable than regular trading, but you have to be aware that margin trading is also more risky, because your capital can depreciate at a much higher level.
Another advantage of contracts for difference is that you can use them on any asset class. You can use them to trade stocks, forex pairs, commodities and even indices. And as if this was not enough, you can also trade short and profit when the market is going down.
If you want to start trading using contracts for difference we recommend Plus 500 which is the biggest UK online CFD broker.