Trading in CFDs , or “Contracts for Difference”, is a potentially lucrative yet risky form of investment. CFDs are a derivatives product allowing you to trade on market movements without owning the shares on which the movement is based.

Traders make money by speculating on the future movement of a market – whether that is up or down. CFDs are very tax-efficient – you don’t pay Stamp Duty, as you would when buying shares, as no taxable assets change hands.

CFDs are leveraged products which allow you to get the full benefit of the market movement while only putting a small proportion of the share price up front. This means a high potential for return on investment but also higher risk. You also need to pay attention to the overnight financing charge, one significant difference between CFD trading and share trading, which can really eat into your profits.

CFD trading gives you the option to go long (buy) if you think the market is rising, or go short (sell) in one that is on the decline. If you believe that a share price is likely to fall in the short-term, you can sell and your profits will rise with any fall in the price. However, if you have got it wrong and the market moves in another direction, your losses will increase.

There are three types of CFD trading:

Short-term trading, which avoids overnight financing charges by working in days rather than hours. This can be a relatively safe bet as, while CFD trading tends to work in volatile markets, very few of them will completely collapse over the course of a day, allowing you to take your profits out in time.

Long-term trading, which works in weeks or months, is a very different way to trade in CFDs and means you’ll need to be able to ride out market fluctuations. They also incur interest which is charged daily to your account. Going short can be a better option in this arena than going long, as shares often fall faster than they rise.

Pyramid trading allows a further increase in the potential return on your investment, allowing you to back a position when the markets have already started to move. When the markets move up, you invest more in your position, increasing your profits. Of course, this also increases your exposure and the speed of potential losses. Pyramid trading requires you to keep a close eye on any market developments.

CFD dos and don’ts:

– Keep a cool head and don’t be greedy. Do your research before you enter a market and cut your losses quickly.

– Cold, hard logic and statistics are all you need. Emotions and intuition can cost you dearly – just ask those who carried on backing Northern Rock after the stocks started to plummet.

– Timing is everything – getting into the markets early in the morning, and profiting from the last-minute flurry at close of play, can maximise your profits.

– Ask your broker for a private account rather than an intermediate trading account, allowing you to work faster and get access to the best spreads.

– Understand leverage and don’t over-expose yourself to risk.

– Don’t get in too deep. CFDs are risky investments and offer you the best return when part of a trading portfolio that includes traditional equities.

Now you have a better understanding of CFD trading it’s time to test out your new skills on the open market. Just remember the best way to success is taking it slowly and doing your research.