Your guide to CFD trading
Trading typically involves the exchange of one asset for another – such as a currency exchange where you may want to trade your rand for euros. However, CFD trading doesn’t involve any actual physical exchange of ownership.
Therefore, while you can trade CFDs on currencies, stocks and commodities, this process doesn’t involve an actual exchange and you won’t be owning the underlying asset at any point of the process.
What is CFD trading
CFD (Contract for Difference) trading refers to buying or selling a number of contracts which derive their value from the price of the underlying asset in question with the hope that the asset will appreciate or depreciate in value. In short, if you think a certain stock or commodity will rise in value, ideally you would want to buy a CFD contract in that stock or commodity and sell it as soon as the price has reached its peak to realize a profit.
As such, you should consider CFDs as a speculative instrument which enables you to profit from price movements in the financial markets if you are able to accurately predict if the prices will go up or down. The main concept is the same for all underlying markets and the bigger the price movement from the time you buy the contract until the time you sell it back – the higher the profit potential.
However, CFDs also provide you with the incredible advantage of being able to profit even when a stock or commodity is losing its value and the market is crashing. For example, if oil prices are about to tank because of instability in the Middle East, you can sell a large number of CFDs on oil and your profits will reflect the amount the price oil dropped.
Also, since CFD trading takes place online with millions of traders taking part in the market, they can be traded 24 hours a day, 5 days a week and you can hold your positions open as long as you like. This means that you can effectively hold your contracts open indefinitely and close your positions only as soon as they realize some profit.
CFD trading is undoubtedly the easiest way for individual investors to access the financial markets from any place in the world and at any time. With only a few minutes of trading per day, you can generate additional income while sitting on your computer or smartphone.
How CFD trading works
After opening an account with a trustworthy forex broker, you can trade CFDs in these few simple steps:
- Select an asset
As already mentioned, CFDs give you access to a wide range of tradeable assets including currency pairs (EUR/USD, GBP/USD), stocks (Google, Apple, Amazon), commodities (Gold, Oil, Coffee) and even cryptocurrencies (Bitcoin, Litecoin, Ethereum).
You can trade any financial asset available at your broker of choice any time you wish. You can either focus on a single currency pair or stock or even trade multiple markets at the same time.
- Choose whether to buy or sell
After selecting the asset you wish to trade, you will have the choice of buying or selling. If you think the price will go up, you should buy or go long. In case, you believe the price will start falling, you should sell or go short instead.
- Adjust your position size
Next, you need to think about your position size or how many CFDs you are going to trade. Regardless of the actual value of the asset you are trading, the position size is what affects the amount you are going to invest. If you want to limit your risk in any given trade, you should limit the amount you invest by reducing your position size, but do make note that this will also reduce any potential profits as well.
- Use automatic stops
Since it’s up to the trader to close a position as soon as it realizes a profit, you should ensure that you are using the automatic stop losses and take profit limits offered by the platform. These tools are crucial in protecting you from unnecessary losses by closing your position before you sustain a large amount of losses, but also securing your profit by closing your position as soon as your profit target is met.
These options are available as soon as you try to buy or sell a CFD and are vital for traders who don’t have the time to monitor their platform throughout the day in order to be able to react and close positions in time. Stop loss and take profit orders are automatic instructions and are executed by the trading platform as soon as the price hits your predetermined levels.
CFD trading costs
Depending on if you are buying or selling a CFD, you will receive a different price and as usual, sellers in the market will offer a slightly higher price for an asset than the ones who wish to buy. These two different prices are referred to as bid and ask respectively.
- The bid price is the one offered when you sell a contract
- The ask price is the one offered when you buy a contract
For example, let’s take a look at the following currency pair quote – EURUSD: 1.1110/1.1120. Here, the first price is the bid price which as we explained is the price of selling a contract in EUR/USD while the higher price is one for buying a contract.
Depending on how many points the market moves from the time you open the contract, your profit will increase accordingly.
You will also notice that there is a 0.0010-point difference in the above prices and this is the referred to as the spread. The spread is the fee paid to your broker for facilitating this trade and therefore you should aim to find a broker that offers the lowest spreads possible. However, it’s also important to note that spreads may vary depending on the asset and many times spread pricing may change – especially during volatile market conditions where prices fluctuate rapidly.
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