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CFD trading offers traders the opportunity to speculate on the price movements of an asset without owning the underlying asset. Contrary to traditional investments, CFD trading allows traders to take positions even when prices are falling. CFD trading provides traders with access to exchanges from around the world, such as cryptocurrency, stock, commodity and index markets, all in one trading environment.
CFD trading – what exactly are CFDs?
It’s best to start with the basics of contracts for difference. A CFD is a derivative instrument whose current price is a reflection of the price of the underlying instrument. It is important to know that CFDs are not listed on any stock exchanges, as they are not standard financial instrument products. Their design is more like a bet than an investment. However, for a trader who knows what he is doing, CFD trading is a nice source of earnings. CFDs are instruments on which traders can trade with Forex service providers, i.e. brokers. Also brokerage houses, which have forex platforms in their offerings, make CFD trading available.
The fact that CFDs are not listed on any exchange is associated with both pros and cons. The main advantage is the large range of brokers, competing for customers and deciding on their own what trading conditions they make available to clients. The lack of a central institution also has disadvantages in the form are differences in quotations in CFD data at different providers.
For example, the CFD rate of the USD/PLN currency pair at one broker can reach a maximum of 4 zlotys and 21 cents, while the same rate at another broker in the same period can reach 4 zlotys and 23 cents. This is why it is so important to choose the right forex broker and forex platform. It is best to avoid those brokers that are not licensed or operate from so-called tax havens.
How is the CFD contract different from other financial instruments?
The CFD contract has several features that distinguish it from other instruments on the financial market. These are primarily:
- A derivative financial instrument, that is, it is not a financial paper, and its value depends on the underlying instrument. A specific person does not become the owner of a specific asset,
- It functions on the principle of leverage, that is, with a small amount needed, you can get much more exposure to the market,
- Has the ability to take a long position when a specific person thinks prices will rise or a short position when he thinks prices will fall,
- A trader can make money on both the rise and the fall,
- CFDs are a flexible form of investing.
For whom were CFDs created?
It is worth knowing that these are very complex instruments. Through the use of leverage, it is possible to earn a lot on it, with a small initial capital. This, however, has not only advantages, but also disadvantages. The chance of high profits is also the possibility of high losses.
CFDs are certainly instruments that are aimed particularly at traders who are willing to take high risks. This does not mean, however, that traders with a lower level in terms of investment risk tolerance should not engage in CFD trading. In order to reduce the risk, it is enough to reduce the level or not use leverage at all.
What can a CFD trader trade?
In addition to stocks, you can trade a variety of instruments in CFDs. CFDs are very flexible, so you can use them to trade virtually any type of financial instrument. Popular types of CFD contacts include:
- Forex CFDs,
- CFDs on stocks,
- CFDs on cryptocurrencies,
- CFDs on commodities,
- CFDs on bonds (read also: Stocks nad bonds),
- CFDs on ETFs.
These are the most popular types of CFD contacts, but it is also possible to trade CFDs on less common types of underlying assets.
For example, there are CFDs that track the value of real estate or works of art. In each of these types of assets, the value of the CFD contract directly follows the price of the underlying asset. For example, a person who starts trading CFDs on Bitcoin. In the event, as the value of Bitcoin increases by 2%, the value of his CFD contract on Bitcoin will also increase by 2%. The same applies to forex, index, commodities and all other assets that are traded in CFDs.
CFD trading – how to use CFDs on stocks?
The underlying instrument of a CFD contract can be a stock. In this case, the person who buys with the help of the CFD contract does not become the owner of the securities of the company in question. With this type of contract, it is very easy to gain exposure with leverage to the stock price of a specific company. Buying shares in a standard way, does not provide such opportunities. In terms of practice, the parties to the contract speculate on the direction that certain shares will take in the future.
CFDs on shares allow for short selling and provide ample opportunity to speculate on the rise and fall of their price. In addition, this type of CFD is more attractive in terms of price than buying securities of a listed company. The prices of stocks and stock CFDs are really no different from each other.
Because of CFDs on stocks, small traders who do not have the financial capacity to become shareholders of a stock company have access to investing (read more: How much money can you make on stocks). The process of investing in such assets using a contract is very simple. All you need is to set up an investment account on the platform of the selected brokerage house. Besides, stock contracts can be easily settled without separate accounting for dividends and capital gains. Besides, a CFD on stocks allows you to access companies on exotic exchanges, such as Saudi Arabia. As for these companies, buying securities can be difficult on the European market.
Trading CFDs on cryptocurrencies
Contracts for difference on cryptocurrencies offer the chance to make a profit by predicting the future movements of selected cryptocurrencies without having to commit a large amount of capital. However, as with standard CFD trading on an exchange, there is an element of risk. Specifically, although the trader does not need a large initial capital, he or she is responsible for all losses.
Like standard CFDs, this type of trading allows investors to take advantage of market fluctuations. CFDs or contracts for difference allow one to predict or speculate on the future price for a specific asset (cryptocurrency), with relatively low initial costs.
How do CFDs for cryptocurrencies work?
CFDs on cryptocurrencies work in that the trader makes predictions that concern the future of the digital currency. In each case, the trader must post a small percentage of the value of the asset as collateral for trading. In such a mode, cryptocurrencies can be traded in various pairs (read also: Investing in cryptocurrencies). Trading operations can be performed with such currency pairs as BCH/USD, LTC/USD, ETH/USD, among others.
Despite the limited number of currency pairs, there is ample opportunity for profit. As one gains experience, it makes the most sense for someone starting to trade CFDs with cryptocurrencies to use one or two currency pairs.
Are cryptocurrency CFDs legal?
Trading CFDs on cryptocurrencies is legal in most countries. However, as of 2021, the FCA has stated that it is an unlawful practice in the UK. Other than that, there are no other known bans that apply to CFDs on cryptocurrencies, including Bitcoin. This, however, may change in the future.
Is buying cryptocurrencies CFD trading?
Although a trader can buy and sell cryptocurrencies through CFD trading, this is not the only way to buy cryptocurrencies. Users usually buy cryptocurrency assets on spot trading platforms, trading tokens without using leverage. The result is that tokens are usually bought on a CFD platform only when they are used for day trading.
Are all cryptocurrencies CFDs?
No. It is also possible to buy, sell and trade cryptocurrencies at the market price, through spot trading. CFDs give you the opportunity to anticipate future fluctuations in asset prices and profit from them.
Like buying and selling stocks, spot trading is another method of trading in the cryptocurrency market. For those investors who want more certainty, at the beginning of the journey it is better to start spot trading before moving on to CFDs (read more: Forex for beginners).
Forex CFD trading
CFDs in this case represent alternative methods of trading Forex currency pairs (read also: What is the best currency to make money on). Quotes in this market consist of 2 currencies – a base currency and a quote. A currency pair can be a reflection of the strength of one economy against another, and the exchange rate is a function of the relationship between the two economies. Before trading CFDs, a trader should try to understand and consider the various political, technical and economic events that have the greatest impact on each currency.
Forex vs. Forex CFDs
Standard Forex trading and Forex CFD trading are not the same thing. The basis of Forex trading, on the one hand, is the exchange of a specific amount of one currency for another. For example, if a trader intends to buy GBS/USD, he will make a profit if the pound rises against the US dollar.
But on the other hand, CFD trading allows you to realize leveraged trading on currency pairs by speculating on the movements of the underlying. Instead of settling for a specific amount of the underlying currency, CFDs are settled in cash and based on the difference between the opening and closing prices of the currency pair.
One of the most important features of CFD trading is that by using leverage, you can increase the size of your trade while devoting a relatively small amount of capital to it. You have to take into account that increasing the exposure raises the potential profit, but also the potential loss.
What is the difference between a futures contract and a CFD?
Forex pairs can be traded in many different ways. Two of them are futures and CFDs. It is useful to know what the differences between them are.
- They are usually traded on exchanges,
- some of them have an expiration date,
- are settled for longer periods,
- in this market the broker acts as an intermediary, not a counterparty.
- have no expiration date and can be closed at any time,
- are short-term speculative products,
- in the transactions of these contracts, the issuer acts as a counterparty.
Benefits and risks of Forex CFD trading
The benefits when it comes to Forex CFD trading are first and foremost:
- High liquidity – the market is extremely liquid, as it operates 24 hours a day during the week, except on weekends,
- Globality – Forex is a large market, with an average turnover of $6.6 trillion,
- Accessibility and ease of use.
CFD trading – indices, commodities, metals
Indexes offer a diverse portfolio of stocks, belonging to top companies and are highly diversified. They can follow the health of specific economies and are influenced by the direction of interest rates, currency strength and employment data.
Commodity CFD trading is also available. These are divided into agricultural, or soft/crop products, and energy, or hard/extracted products. Examples of commodities include sugar, coffee or wheat.
Trading CFDs on metals, on the other hand, allows an investor to join this fascinating market without owning a physical product. Gold and they precious metals are considered a safe haven and are often used as a hedge in uncertain times (read also: Gold investments or Investing in gold).
Risks of Forex trading with CFDs
Although Forex is multifaceted and associated with many benefits, it can also bring risks that traders should be aware of. Here are some factors that should be taken into account when trading Forex:
- high volatility – there are highly volatile exchange rates in this market and this means that the prices of Forex pairs can fluctuate in a relatively inconsistent manner over very short periods of time. Therefore, they can be unpredictable,
- unpredictable currency markets – the market is affected by various factors, including political decisions, socio-economic issues, etc., so predicting currency markets can sometimes be really difficult,
- inexperienced traders – as with any other market, lack of education, as well as inexperience and knowledge can generate losses; therefore, it is recommended that investors continue to educate themselves and be aware of the market and how it works.
CFD trading is inextricably linked to risk, but traders can learn to manage it properly.
CFD trading – managing risk
Leveraged CFDs, like any other derivative product, are riskier than proper trading in the underlying instrument, for the sake of increased exposure. In order to manage the risk wisely, it is worth using special tools for this purpose, which are able to help the trader take control of the transactions and manage the risk.
This can be, for example – “close with profit” to close a particular trade when it reaches a certain level of profit or “close with loss” to limit the risk to a given value. In addition, traders can try to calculate the potential profit and loss, through special ratios.
It is worth remembering that although profit management tools can help with reducing the chance of getting a loss, nothing is guaranteed. Therefore, when deciding to trade CFDs, you should allocate to it exactly how much you can lose in the worst case scenario.
CFD trading – risks
Be aware that trading in CFDs is considered to be highly risky. Brokers post information on their websites about how many percent of accounts suffer a loss within CFDs. It’s also a good idea to analyze trading costs before entering into it, taking into account SWAP points.
Investing in CFDs, or rather with their help, is associated with high risk, and despite this, a lot depends on the attitude of the trader. If it is a person who has a lot of experience in the financial markets, he is able to predict the consequences of his actions, as well as sense the downward and upward trends of his own assets. Such a person is able to react quickly to limit losses.
However, a novice trader may find it difficult to find his way around the subject of CFDs. In particular, the deposit should be kept in mind, because if it is too low and the trader inadequately assesses the risk, he will lose capital and may even be at a disadvantage. The risk associated with CFDs depends on the trader’s experience and leverage.
CFD trading – making money on ups and downs
The advantage of CFDs is the ability to invest in both ups and downs. This is related to the design of CFDs. CFD is exactly about earning or covering exchange rate differences. For a forex platform service provider, the direction a trader takes does not matter. The customer can enter into positions, betting on the ups or downs of a specific instrument.
How to make money on declines with CFDs?
The fact that investing in CFDs on declines is very simple is evidenced by the fact that the purchase on the trading platform is right next to the sell button. The design of the instrument itself is very simple, so the only thing a trader needs to focus on is analyzing whether a specific market will rise or fall. It is also important to properly calculate the risk, which depends on the investment strategy adopted by the investor.
CFD trading – fees and transaction costs
It is about this issue, go costs in the Forex market vary strongly (read more: Forex investments). First of all, it depends on the selected Forex broker.
The standard cost is the spread
This is the difference between a bid or a sell. This cost can be significant on unpopular assets. When the broker chosen by the trader operates in the ECN, STP or MTF model, then in addition to the spread the trader must take into account commissions. In such a situation, the spread will be lower than in the case of a typical market maker, and the commission will not be high. As for 1 lot for the most popular currency pairs, the commission oscillates between $1 and $10. It all depends on the chosen
Forex service provider.
As for CFD trading, the spread itself will also be different on different platforms, and in the case of the EUR/USD pair, it can range from 0 points to 3 pips. However, there is one cost that is not particularly important for most traders.
SWAP – the cost of holding a position for the next session
It is mainly about holding a position beyond one trading session. This cost is less than the price of the spread or commission. For short-term traders, this cost can be ignored in these calculations. The problem begins when the trader will want to hold the position, for example, for several months. In such a situation, the cost of holding the position will be a significant cost for him and may even determine the profitability of the entire investment. In some cases, it may turn out that SWAP will be an additional profit for the trader, and this all depends on the difference in interest rates on certain assets.
Are CFDs Forex and can you make money there?
Many people equate CFDs with the Forex currency market, also claiming that it’s a place for speculation and an ordinary person can only lose money that way. However, Forex is a place where currencies are simply exchanged (read more: How to invest in currencies online. Trading there are institutional players, governments, banks, corporations, but also retailers. Forex is home to scammers who extort money from beginners, so be careful.
An investor who loses all his savings there will certainly not have a good reputation when it comes to Forex trading. However, making money on Forex is as possible. One can venture to say that even a person who keeps foreign currency in his account in order to sell it at the right moment, in a sense participates in the Forex market, because he influences it, by operating his foreign funds. Forex is not the same as CFDs. It is a type of instrument that is used in this market and more.
CFD trading – advantages
CFDs are among the most popular instruments on the OTC market. They have many advantages that make them of interest to many investors.
The main advantage when it comes to investing in CFDs is leverage, or the use of leverage. This mechanism allows traders to have more capital than they actually have. Depending on the amount of leverage, he can enter into trades that have a value as much as tens of times the value of the deposited funds. This has not only advantages, but also disadvantages. When using leverage, in a situation where an inappropriate investment decision is made, the trader suffers a greater loss. Therefore, novice investors use low leverage.
CFDs also have the advantage of easy access. Currently, most brokers have them on offer. To invest in them, you only need to open an account with one. It takes a few moments to set it up and can be done completely online (read more: Online forex). In addition, it is usually free and the trader does not need a large deposit.
CFD trading – disadvantages
CFD trading also has its disadvantages. What are the negatives that investors have to deal with?
High investment risk
Investments in CFDs are associated with an increased risk of losing funds. The reason for this is leverage. Typically, investors’ losses are recorded in more than 70% of accounts. Every investor should bear this in mind before trading CFDs.
In addition to the high risk, the disadvantage of investing in CFDs is the fees, associated with holding positions. With many currency pairs, brokers charge the so-called SWAP. If it is negative, the trader can lose a lot on it. However, it should be mentioned that when it is positive, the trader can gain a lot from it. So, before he trades, he should carefully recalculate the swap points and see how they will affect the final result of the transaction.
What are the differences between CFDs and ETFs?
There are big differences between CFDs and ETFs especially when it comes to investment risk. The point is that CFD trading is an efficient speculative trade that is based on market trends and the trader’s views. An ETF, on the other hand, is an asset that holds shares in age-old companies in which the trader can invest (read more: Investing in ETFs).
Some ETFs can be over-invested in a single company, leading to potentially extreme movements in the value of an investor’s portfolio. But the ability to invest in multiple companies means that the trader has a properly diversified portfolio and is more likely to make a return.
Comparing ETFs with CFDs, the latter give the trader the ability to control the companies he invests in based on his preferences (read more: Exchange-Traded Funds). This will allow the trader to follow the stock market index, as opposed to an automated process. In this case, the advantage is that the trader has more control over what he thinks will give him the greatest return, regardless of whether it actually does.
Is it worth trading CFDs?
Trading CFDs carries many positives over standard trading. Among these advantages, the trader has a much wider choice of financial assets, which is also accompanied by a heavily diversified selection of high-quality and user-friendly trading platforms. It’s worth exploring the other advantages that come with making money on CFDs.
Higher leverage than in traditional trading
With CFDs, the available leverage ranges from 2:1 to a maximum leverage of 30:1. This gives the trader the opportunity to maximize his profits from CFD trades with as little capital as possible.
No restrictions that apply to selling short
Some standard trading markets do restrict short selling for ethical reasons, but CFDs can be shorted at any time. This gives you the chance to speculate on both good and bad news. This is because the CFD trader never physically becomes the owner of the underlying asset.
Access to professional platforms
Most CFD brokers provide the best CFD platforms for traders. They allow traders to enter the same types of orders as the most ordinary stockbrokers, such as profit or stop loss orders as well.
This type of software also provides a wide range of charts and news releases to keep traders fully informed about technical and fundamental factors.
A diverse range of available financial assets
There is an ever-growing spectrum of financial assets available that are made available by CFD brokers. However, it does not only apply to commodities or stocks (read more: How to invest in stocks). Currently, it is possible to trade Forex contracts, indices, and it is even possible to make trades on newly emerging cryptocurrencies.
This is one of the main advantages of CFD trading – you don’t need to own the underlying asset. This may not seem very important if a trader only trades stocks, because usually stock certificates are held in a digital stock trading account and require no effort on the part of the trader to buy or sell them.
Read also: Making money on forex
This is especially important when trading currency pairs or commodities such as oil. In order to buy oil directly, you need to have transportation for barrels of oil, as well as storage facilities.
The best CFD trading platforms
When looking for the right CFD platform, look for reputable CFD brokers that offer the lowest spreads. Which brokers are the best?
Users of this broker have access to more than 200 CFD assets, such as cryptocurrencies, currency pairs or commodities, and company stocks. Available leverage is always 30:1 on European markets. This broker offers platforms such as Meta Trader 4 and Meta Trader 5. It also gives access to a demo account for virtual money, so you can understand the system and markets. The broker requires a minimum deposit, which is 100 base currency – i.e. in United States this will be USD100. To take full advantage of the services that are offered by this broker, it is best to deposit between 1000 and 2000 base currency. AvaTrader is regulated by the Central Bank Ireland in Ireland.
CFD trading can be done with the help of Plus500 broker. This service provider gives traders access to many thousands of CFDs on stocks, Forex, commodities, ETFs, indices, options, etc. In this case, the maximum leverage is also 30:1. This broker provides its own investment platform for users.
It also offers the possibility to use a demo account. Plus500 allows users to deposit as little as 100 euros to start trading CFDs. The broker is fully regulated by the FCA.
The eToro broker offers more CFDs on stocks than Plus500, but not so much when it comes to Forex or indices. It is, however, a specialist in the area of CFDs on cryptocurrencies. Here, too, the maximum leverage is 30:1. eToro has its own trading platform. The broker gives the opportunity to check the functions of the CFD platform on a demo account. As for the minimum deposit, the deposit on eToro must be $200. The broker is regulated by the FCA and the Cyprus Securities and Exchange Commission.
It is worth knowing that it is not possible to master CFD trading in one day. To develop your skills and gain experience, it is worth using a demo account.
Demo account vs. CFDs
Most brokers who trade CFDs allow beginners to create a demo account for a specific period (read more: Forex demo). Under such a demo account, the trader will be able to trade in the market with virtual money. This allows one to learn about the operation of the markets in which the client is interested. With a demo account, a trader can get acquainted with the types of orders he can place in the market.
CFD trading applications
For those who are interested in trading CFDs on the go, making and monitoring positions on all types of CFD contacts, using mobile apps can be a good solution. The following are those that are worthy of attention.
This app is compatible with devices that are equipped with Android and iOS. It gives traders access to 250 CFD instruments, including in particular Forex pairs, indices, stocks, etc. The app is equipped with modern technology that allows convenient monitoring of markets in real time, as well as social trends among the CFD trading community.
The app is also available for iOS and Android devices. It allows you to trade CFDs and use leverage on everything – stocks, Forex, etc. The Plus500 app has a free unlimited demo account, along with the ability to practice CFD trading strategies using play money. In addition, it also offers 24/7 customer support and functionality in many different languages.
More than 2,000 different CFD instruments – for stocks, cryptocurrencies, indices and more – are available on this platform. Through the eToro app, you can trade CFD stocks and pay no commission on all trades. The app also allows you to monitor social activity on eToro to stay up to date with trends and real-time analysis and analytics.
CFD trading – what can cause loss of capital?
Of course, it is best to approach CFD trading in a positive way and pay attention to the benefit it can bring to an investment portfolio. However, it is also worth considering the potential risks to an investor’s capital:
- Choosing an unregulated broker – too many beginners make the mistake of choosing inappropriate brokers and putting money on deposit. Before an investor does this, wanting to start making money on CFDs, he should find out reviews, regarding the chosen broker,
- Unexpected changes in the market – even the best CFD traders can skin sudden fluctuations in the market. Given the characteristics of the market in real time, economic and political changes can very quickly lead to negative effects on the value of the underlying assets and subsequent contracts,
- Illiquid futures contracts – in less bright and clear markets with fewer realized traders, open contracts can become illiquid. Intermediaries providing CFD platforms, may charge additional margins and even close contracts at much lower prices. Illiquid contracts are those that are not in focus and are best avoided.
CFD trading, although it carries a relatively high risk, is still quite popular among investors. However, it is recommended for more experienced people who have knowledge of the subject. Beforehand, it is always a good idea to test your skills on a demo account, which is possible for free.