CFD Trading Explained
CFD stands for Contract for Difference. It is a future-style derivative trading. This simply means that the trading plan allows you to place a bet and speculate on the rising or falling of anything that is currently being traded in a fast-moving global market. The CFD, therefore, is pegged on another asset, also known as the underlying asset. I’ll explain: Suppose you want to trade on 1 Bitcoin's price, and the trader is declaring the current price of a bitcoin at 100 US dollars. You intimate that in two weeks, the price of each share will go up. You enter into an over-the-counter contract with a trader who accepts to take a risk in daring your position. You then give him 100 dollars, the price of a bitcoin, or a fraction that he accepts (by applying a margin) so that he can lock it into the contract. The trader will pay you any price increase beyond 100 dollars exactly two weeks after contract time.
You must also bare in mind that you will have to pay him the difference between a hundred dollars and the bitcoin’s price in exactly two weeks if the price goes below 100 dollars. In this example, you didn’t buy the stock item you were speculating on. You just speculated on the price fluctuation of the item. Speculating on the rise of the value of a particular item and placing a bet on it is known as trading ‘long.' The opposite is called trading ‘short.' Get the drift? Yes! I just said that you could make money by speculating about the fall in the value of a stock, just as much as you can when you speculate on a rise.
A little CFD history lesson before we proceed
CFDs, like many other things, started in the United Kingdom in the early 90’s. Brian Keelan and Jon Wood, both of UBS Warburg, carried out the first CFD deal on Trafalgar House, a conglomerate that had interests in many industries including engineering, shipping, hotels, and construction. The concept quickly started gaining traction with hedge funds. Retail traders quickly joined in.
Companies and countries that engage in CFD trading
Online Trading platforms include AlfaTrade, CMC Markets, CityIndex and InterTrader among others. Currently, contract for difference trading is possible in the UK, Russia, Japan, Canada, South Africa, Switzerland, Canada, New Zealand among other Countries.
The diversity of ͚underlying assets
From our example above, bitcoin is the underlying asset. So this means that it is the stock item whose value you are speculating on. While CFD trading is not practiced in the US due to lack of proper regulations, it is now widely spread across Europe and in Australia, as seen above, and it is a growing market. Mainly, you will find CFD trading platforms that offer to trade for stocks like FaceBook, Google, etc., but there exists a thriving and growing market for Commodity CFDs, which include such commodities as oil, sugar, coffee, gold, wheat, soybean, etc.
Why trade a CFD for a commodity if I can simply trade the commodity?
Commodities usually have small marginal investments. For example, you may wonder why anyone would want to trade CFD on a kilo of wheat which can be available for a price of $1. Here comes the best part: The underlying asset is a gateway for you to speculate on the asset without actually owning it. Let us see what advantage we can get from that capability.
Advantages of CFD trading over commodity or stock trades "The power of Leverage and margins" A margin is the percentage of the value of an underlying asset that a trader will offer as the minimum trading balance. For example, if you want to trade on the bitcoin in the example above which has a value of 100 dollars, and your trader is offering a 10% margin, you could start off with a minimum deposit of $10. With leverage, your margin controls an underlying asset of much higher value. For example, you could be using the $10 to leverage the whole bitcoin and earn an equivalent of its gain or loss in the agreed contract time. In other words, somebody else had to invest 100 dollars to buy one bitcoin and earn the same gain you have made through leverage, at the same period. You can make crazy returns if you are using leverage and caution well, and lady luck is on your side. Or it can sink your funds fast if you fail to exercise caution and business sense. As with trading with cryptocurrencies which are reputed to be volatile, we can say here that only invest in CFD trading what you are willing, and can afford to lose.
If you speculate well, you can make money on markets whether they are gaining or losing. If you think they are losing, you sell (going short), or if you think they will gain, you buy (going long).
CFDs are diversifications of existing trading platforms.
If you are already a trader on an online platform, you already are familiar with most of its tools. All you now need is to learn how a contract for difference works and you are good to go.
No fixed order sizes
Successful CFD Traders Use leverage to vary various CFDs on the platform by taking advantage of flexible lot sizes.
And now, the Kicker:
- Market volatility
The market you choose can take an unexpected turn. For example, if you go long on bitcoin and then someone hacks the blockchain, the negative news could send it crashing in minutes, say to 80 dollars. If you had bought on a 10% margin, it means that you had $10 on that trade. Now that you have lost $20, you have to compensate another $10 to make up the difference from $80 to $100. Another interesting thing to note here is that you can specify the number of units you are bidding on. For example, in the above example, if you put 20 dollars and apply the 10% margin, it means that you are offering on two bitcoins instead of 1. If you lose $20 from each, meaning that you have to part with $40. In short, you can lose more than you have invested if the volatility is high.
Counterparty Liquidity risk
CFDs are largely unregulated. Hence, there exists a possible risk of entering into contracts with traders who are illiquid or fraudulent. If they cannot pay your successful trades, for whatever reason, you may lose your portfolio. It is therefore advisable to research your trading partner before engaging.
Even small changes in the market can have a huge impact on the deposited funds, and therefore it is important to deposit adequate funds to avoid automatic closures and keep positions open.
To trade or not to trade?
When you open a position to trade using leverage and margins, you magnify the effect of your speculation to a level you specify. Have you wanted to own a bit of Google or Facebook but cannot afford? This new trading technique allows you to attach your desired company’s stock as the underlying asset when you trade. You get to own those shares for a fraction of what they are worth. Are you good with the world trade of some commodity? Take time to learn the tips and tricks that matter, then check whether that commodity is offered by AlfaTrade, CMC Markets, CityIndex, InterTrader, eToro, IG Index or any other renowned stock or bitcoin CFD trading platforms.
Overall It is invigorating and extremely eye-opening to learn CFD trading strategies. Not only is it a good way for beginners to learn the art of doing business through speculation, but gradually, your acumen for making good returns through similarly simple and wonderful trading methods will be unstoppable.
Highly volatile investment product. Your capital is at risk. Past performance is not an indication of future results.
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