One of the main tools that Forex brokers offer is CFD contracts for difference. What is it, and what are the advantages and disadvantages of these tools, we will understand further.
The concept of CFD contracts
CFD is an abbreviation of Contract For Difference, which is translated from English. means “contract for difference”. It makes it possible to trade not the financial instrument itself, but its price. Such trading is speculation on the movement of value in any direction. In this case, the trader receives all the benefits inherent in trading shares without actually owning them.
Such a contract follows a change in asset quotes and is concluded for a short period. Its purchase does not imply dividend payments. In addition, transactions are made only between the broker and the trader.
CFD handel was created to meet the needs of stock market speculators with a small deposit, as they only require a fraction of the underlying asset’s price to be deposited. This type of trading is called margin trading, that is, using leverage. Such agreements increase the number of participants, providing access to the market for traders even with small capital.
Let’s take an example: you bought a CFD on Brent oil and the price of the asset rose, in which case the brokerage company that sold it to you will pay you the corresponding difference. If the price falls, the broker will write off this difference from the trader’s account.
CFD Trading Strategies
To make contract trading more profitable and less risky, a number of different strategies have been developed by traders.
- Trades during the week. An investor opens an order on Tuesday and closes it at any time until Friday. Thus, active trading is carried out within one week.
- Long-term trades. In this case, the order will be held for more than 1 week.
- Combined trades. This option provides for a combination of automated and manual trading. It is more suitable for professionals.
- Hedging. Often CFD contracts are used in the market to hedge real exchange positions.
What are the benefits of CFDs?
- Wide range of assets. There are CFDs for almost all financial assets. If portfolio diversification is required, then this is the best tool.
- High leverage. When working with CFDs, you can take advantage of a large leverage (up to 1:500) compared to the stock market. This ensures a low margin – from 2%. Based on the underlying asset, the margin can reach 20%, but not exceed this level. Thus, a trader, having a small amount on deposit at his disposal, can take advantage of markets that were previously inaccessible to him.
- A trader from a single trading platform can work on all markets. Many CFD brokers offer assets from all global markets. Thus, traders can easily work in any market of the world, using one platform for this.
- There are no restrictions for shorts. Some markets have rules prohibiting shorts or requiring a trader to borrow an asset before going short. The CFD handel market does not have a limit on short positions, and a trader can open shorts at any time without incurring additional costs.
- No commissions. Transactions are executed quickly and, as a rule, without commissions.
- There is no limit on day trading. CFDs do not impose a capital limit on day trading, unlike some other markets.
Trading risks in CFD trading
- CFD trading is not suitable for scalpers. All costs are included in the spread, which makes it impossible to make quick deals and make a profit on a small price change. For example, the EUR/USD spread can reach 30 pips, while on FX it is 5-16 pips.
- Weak regulation. Unlike the stock market, CFDs are still poorly regulated, so it is important to read the reviews before trusting a broker.
How much money do you need to trade CFDs?
The answer to this query is determined by the minimum deposit needed by the brokerage firm of choice. It is possible to begin trading with as little as $100. At the same time, the trader will be given the opportunity to trade securities of several worldwide corporations. The most essential thing is to consider the margin and avoid opening a big number of orders at once. CFDs are ideal for novices who wish to test their trading skills with a little stake.
Comparison of CFDs with FX
FX and CFDs have similarities and differences that every trader should be aware of. By learning more about CFDs and FX, it will be easier for a trader to determine what is best for him to achieve his goals.
Both CFDs and FX do not assume that the asset will be physically transferred to another owner. That is, transactions are executed almost identically. Both have access to margin. The margin used by CFD traders is often noted as a fixed percentage.
The next similarity is that CFD and FX spending are included in the spread.
What are the differences? CFDs are a universal asset, they allow you to work with various financial instruments, including stocks, bonds, commodities, cryptocurrencies, and more. FX is open on weekdays, you can trade on FX at your leisure from anywhere in the world. Trading times for CFDs depend on the market or asset the investor has chosen.
Summarizing
- CFD trading gives the trader the opportunity to use a wide range of financial instruments: from metals to shares of large companies.
- At the same time, the work process is significantly easy, thanks to a free trading terminal, lower commissions, and leverage.
- Consequently, the trader has more opportunities to make a profit and increase his earnings.
