Investing in the stock market can seem scary, especially for beginners. But if you're one of the many people looking for ways to make their money work harder because of the cost of living crisis, it might be time to think about it.
The rise of online platforms and more accessible investment options have enabled more people to dip their toes into the world of trading. An increasingly popular method is contracts for difference (CFDs). But what are they and how do they work?
How CFDs work
CFDs are derivatives, which means they allow you to speculate on the price of an underlying asset without actually owning it. This asset can be anything from shares in a company to commodities such as gold or foreign currencies.
Essentially, you agree with a provider on a CFD trading platform to exchange the difference in the price of that asset between when you open and close your position. If you predict that the price will go up and up, you will make a profit. But if your prediction is wrong, you will suffer a loss.
Leverage
This feature means you can open much larger positions than would otherwise be possible with your own money, essentially borrowing the rest from the provider. For example, if the leverage offered is 1:10, you could gain £1,000 of market exposure with just £100 of your own money. While this can magnify your profits, it also greatly increases your risk. If the market moves against you, your losses could exceed your original deposit.
Regulatory oversight
In the UK, CFD trading is regulated by the Financial Conduct Authority (FCA). This provides a degree of protection for investors as providers must adhere to certain rules and regulations. These include segregating client funds from their own, providing risk warnings detailing how many retail accounts are making losses, and limiting leverage to a maximum of 1:30. However, it is important to remember that CFDs are complex high-risk instruments, so you should be prepared to lose everything you invest.
Investor protection measures
The FCA has also taken steps to protect investors. If your account balance drops too low (50% of the required margin to hold your position), the provider must automatically close your trade to prevent you from losing more money than you put in. You can never lose more money than you have in your CFD Account, even if your trades go very badly. CFD trading platforms cannot offer you bonuses or rewards to entice you to trade.
Tax assessments
Profits from CFD trading are generally subject to capital gains tax (CGT). However, you may be able to offset losses against gains to reduce your tax liability. It is recommended that you speak to a financial advisor or tax professional for personalized guidance on the tax implications of CFD trading.