After learning more about CFDs and its features, you may be wondering where these financial instruments fit in your investment portfolio. You may already have a healthy share portfolio that you want to keep growing. While CFDs may not be the ideal vehicle for the long term buy-and-hold investing, it definitely has a place in any investor’s portfolio.
Cheap entry into trading – because you only need to pay a small percentage of the total value of the transaction to open a CFD trade, CFDs can be seen as a relatively cheaper way to get started in trading. Some CFD providers require a deposit amount of only about $5,000. As long as you maintain your leverage exposure to a reasonable level, CFDs can be an efficient entry into trading the markets.
For example, you want to buy 1,000 shares of XYZ company at $8.00 a share. This means you need at least $8,000 to open a trade. If you trade CFDs of XYZ company, you would only need about 5% of the total amount to open the trade.
Portfolio diversification – whether you’re a long-term buy and hold investor, you can use CFDs to take advantage of short-term profitable moves in the market without affecting your long-term investment. This means while your long-term positions are growing over time, you can trade CFDs to deliver profit from short to medium-term trades. To introduce diversification in their investment portfolios, some people prefer to maintain their share/equity portfolio for capital gains and ongoing dividend income while also maintaining a CFD portfolio for short to medium-term investment or trading.
Portfolio hedge – hedging means protecting or trying to minimise any risk that may affect your existing investment portfolio. Many people are now using CFD as a hedge to protect their share/equity investment.
For example, say you have bought 1,000 BHP shares at $33.00 expecting that the price will go higher in the months to come because of the global demand for resources. You intend to keep your BHP shares as a long-term investment. However, after a few days of buying the shares the price went down and it is now trading at $32.75. You still believe that BHP shares will go higher in the medium to long-term period, but in the mean time the share price has been going down for the past few days.
You can short sell 1,000 BHP share CFDs to hedge your share position in the short term. This is because every cent movement in the physical shares (in this case it is going down, therefore you are losing) will be matched by the same movement in the share CFD (in this case, because you have a short position you are making money if the price of the share CFD goes down). This means your losses in the physical shares are being offset by your winnings in your short CFD trade.
Things to remember:
-You can easily trade CFDs as you trade shares because the price of a CFD mirrors the price of the actual share.
-CFDs are much simpler and easier to understand and trade compared to other derivatives such as options and warrants.
-Consider CFD as a tool to diversify or hedge your existing investment portfolio.