Investing in the stock market can seem daunting, especially for first-timers. But if you’re one of the many people looking for ways to make their money work harder due to the cost of living crisis, now might be the time for you to consider it.
The rise of online platforms and more accessible investment options have enabled more people to dip their toes into the world of trading. One increasingly popular method is trading 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 could be anything from shares in a company to commodities like gold or foreign currencies.
Essentially, you’re agreeing 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 the price will rise and it does, you’ll profit. But if your prediction is wrong, you’ll incur a loss.
Leverage
This feature means you can open much larger positions than would otherwise be possible with your funds, effectively borrowing the rest from the provider. For example, if the leverage on offer is 1:10, you could gain £1,000 of exposure to the market with just £100 of your own money. While this can magnify your profits, it also significantly increases your risk. If the market moves against you, your losses could exceed your initial 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 that detail how many retail accounts are making losses, and limiting leverage to a maximum of 1:30. However, it’s crucial to remember that CFDs are complex, high-risk instruments so you should be prepared to lose everything you invest.
Investor protection measures
- The FCA also has measures in place to protect investors.
- If your account balance drops too low (50% of the required margin to maintain your position), your 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 can’t offer you bonuses or rewards to tempt you into trading.
Tax considerations
Profits from trading CFDs are generally subject to capital gains tax (CGT). However, you may be able to offset losses against gains to reduce your tax liability. It’s advisable to speak to a financial advisor or tax specialist for personalised guidance on the tax implications of trading CFDs.