CFD trading has increased recently, with a noticeable surge in 2020 during the pandemic. Many individuals have found trading with CFDs one of the more appealing methods when compared to traditional investing. It is as real as any form of traditional investing or trading but has some unique aspects that set it apart from other forms of investing or trading.
One of the reasons for CFDs’ appeal is that a contract for difference (CFD) allows you to trade a currency pair, a stock, an index, or a commodity without owning it. When you trade a CFD, you simply look to make a gain (or could make a loss, unfortunately) by buying it for less and selling it for more. But unlike investing, when you trade CFDs, you don’t exchange any physical assets.
Another reason for their appeal is how easily accessible they are with limited capital. If you’re a beginner, trading CFDs is very real and attractive, as it allows you to trade with less and manage your positions without excessive risks.
Leverage is one of those infamous aspects of CFD trading that is very often misunderstood. The trader can put in less money and borrow the rest from the broker in order to open bigger positions with the use of forex leverage. So, in other words, you can trade with more money than the value of your account, allowing you to go after bigger profits. The downside is that you may equally incur massive losses if the market moves sharply against you.
Professional traders and CFDs
For the savvy trader, CFDs provide the opportunity to implement more advanced strategies. Professional traders tend to use CFDs for hedging or speculation. In this sense, their goal is to gain from or hedge against the risk of price volatility. Institutional investors like hedge funds or stock portfolio managers can also use CFDs to manage investor funds.
What they do is utilize CFDs to gain flexibility by adding them to their existing investment options and to manage the risk from the price volatility of their own portfolios. Institutional fund managers can use CFDs to gain access to cheap leveraged exposure on multiple instruments, opening short positions to grasp opportunities from declining markets.
Interesting facts when trading CFDs
One of the things that traders very often ignore is the ability to trade on a smaller account and at a smaller size. Very often, traders focus on bigger, higher, or larger options and may forget that smarter choices may come in smaller sizes. Not everything has to be bigger, and this is especially the case for beginners who are still learning their way around trading. CFD trading allows you to be much more accurate in your position sizing, as a smaller contract gives you much more risk control than a larger contract.
A smaller position size also means that you can split your trade into multiple positions. Ideally, you can split a trade into three positions and close them at separate points, taking some profit whenever you can and leaving some for a bigger win.
You can offset potential losses by hedging your stock portfolio and earning interest. If you believe the market will go down but you don’t want to sell your stocks, you can go short on an index with a CFD contract and profit when it goes down. So whatever profits you make in the CFD, you will be able to offset the losses in your stock portfolio.
One of the reasons CFDs are so popular is the ability they offer traders from around the world to trade anytime they wish. CFDs provide you with access to the global markets that trade 24 hours a day, 5 days a week.
CFD trading terms you should know
You may have heard of leverage, margin, and going short, but what do they really mean?
Leverage and margin
When you open a CFD position, you have the ability to put down a small deposit that could be anything from 5% to 10% of the position’s cost. This is called leveraged trading, and the deposit you must have in your account is your margin.
CFD leverage gives you more flexibility since you don’t have to tie up all your available funds in one position.
As we already mentioned before, leverage is a powerful tool, but you should be careful and take the right risk management measures.
Spreads and commissions
You’ll always see two prices when trading CFDs. The first is the sell price, and the second is the buy price. The difference between the two is the spread. When you trade CFDs, the costs are added in the spread, so you don’t pay a commission. Other times, the spread may be smaller, but you may have to pay a commission. Being aware of the relevant costs and calculating them upfront will help you organize your trades and manage your capital better.
Shorting
On long positions, traders will open a position at the buy price and close at the sell price. CFDs are great as they allow you to also do the opposite: open a trade at the sell price and close at the buy price. This is what is called shorting.
With CFDs, you can go long and profit from the price going up or go short and profit when the price goes down. Because a CFD is just a contract where your broker agrees to pay you the amount when the market has moved in your favor, and because you don’t actually own the underlying asset, you can choose to speculate on either market direction.
For example, if you go long by buying CFDs, you may profit if the market moves upwards when you close your position. If you go short and sell CFDs, then you will make a profit if the market has fallen when you close your position.
Trading CFDs
Trading CFDs is similar to buying other financial assets. If you buy or sell a specific amount of your favorite instrument, how much you buy or sell will determine whether you have made a profit or loss. However, whereas you will normally be trading shares or currencies, with CFDs you will be buying and selling contracts that imitate the live prices of these assets.
If you’re new to CFD trading, then you might want to find the right broker and test the waters with a demo account. CFD demo accounts will enable you to check out the trading markets with virtual currency and explore the various features of the trading platform before you start trading with real capital. You can open a free IronFX demo account in seconds and start trading with virtual funds without risking your real funds.
With IronFX, you can discover how real CFD trading is, explore the wide range of markets the leading broker offers, and build a solid foundation with its wealth of educational material. As a trusted CFD broker, IronFX has the expertise and knowledge and one of the friendliest customer teams ever, as they can help you get started with opening and funding your account.
Disclaimer:
This information is not considered investment advice or an investment recommendation, but instead a marketing communication. IronFX is not responsible for any data or information provided by third parties referenced, or hyperlinked, in this communication.
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