We understand how hard it is to watch investment markets boom without getting a piece of the cake. However, you may want to get in on the action immediately and may have learned that CFDs are investments that arguably provide the most promise for exponential profits.
Nonetheless, you need to relax and learn a few things about these investment instruments before putting all your money in. For instance, many people don’t know that residents of the US are not allowed to trade CFDs.
Our article presents you with all you need to start CFD trading, including a comprehensive definition, trading positions, investment tools, and risks. So let’s get right in.
- Introducing CFD Trading
- CFD Trading Positions
- Assets In CFD Trading
- Leveraged CFD Trading
- Drawbacks Of CFD Trading
- CFD Trading Tools
Introducing CFD Trading
We’ll start by describing what CFD trading is exactly. CFD is an acronym for “Contract For Difference,” which is an arrangement between a buyer and broker on the variance in the price of an asset. As a derivative investment, CFD trading has you maintaining positions on the asset’s price rather than directly acquiring and owning it.
You predict a price trend and only gain a profit when your forecast is accurate. “Contract For Difference” means the difference between the opening and closing price concerning how much money you invested. The seller gets the difference if the price trend is at odds with your forecast.
Since you are not directly acquiring and owning the asset, CFDs give you flexible trading possibilities. For example, you may either engage in long or short position trades, which will be exemplified next.
CFD Trading Positions
Long positions are the default forms of investment trading where you acquire an asset and gain from a rise in its price. With CFD trading, when you get into a long trade, you purchase CFD units hoping that the asset’s price grows, and you only gain profit if your forecast comes true.
Short positions are also called sell positions; peculiarly, you only gain from a price decrease. This is because you earn the variance between the opening and closing price and lose on the investment if the price goes up.
As you may have seen, this is possible when dealing with forex and cryptocurrency through futures trading. However, by default, CFDs include the option of holding short positions.
Assets In CFD Trading
Assets in CFD trading include commodities like gold, silver, and oil, foreign exchange, cryptocurrency, indexes, company shares, and other products in the regular investment markets with prices attached to them.
You purchase CFD units, which are representations of the regular asset units. For instance, when CFD equities are concerned, one CFD unit is equivalent to one share of a company. One CFD unit is equivalent to 200 ounces of gold or silver with precious metals.
Moving further, you may purchase 200 CFD units, with your CFD position costing the equivalent of two hundred units of the same commodity in the regular markets. An example is 200 CFD units of a company’s share, which costs $200 per share, which means your position costs $40,000 (200 × $200). Now, what if you don’t have 10,000 for a trade? This is where leverage comes in.
Leveraged CFD Trading
Leverage involves acquiring a position and paying just a part of its cost. However, unlike in the stock market, which always requires you to pay in full, you only pay some of it in leveraged CFD trading while your broker takes up the rest. As a result, this is the medium through which many CFD traders exponentially increase their profits.
Looking at our previous example, instead of paying $40,000 for 200 shares of a company, leverage lets you pay just $2,000 or even $200 and have the same amount of profit as you would with an investment worth $40,000. Additionally, your leverage options hinge on the broker, with some letting you multiply your trading size by up to 2000.
However, with this comes an apparent problem. This problem presents one of the significant drawbacks to CFD trading.
Drawbacks Of Trading CFDs
Just like your profits, your losses are exponential. This means a little price movement may clear out all the money you have placed on the trade.
What’s scarier is that your losses may go beyond your initial investment or deposit. If your margin (investment value) doesn’t cover the losses and volatility of the market, you are placed in a position of debt to your broker.
Some other drawbacks include the fees you have to pay for holding positions overnight and even the low regulatory standards of the entire CFD market. In addition, a broker may not have the integrity to fulfill his part of the contract.
CFD Trading Tools
There are investment tools and strategies you may apply to CFD trades to maintain profits and even prevent these exponential losses from completely affecting you. The most important of these are the take profit and stop loss orders.
Placing a take profit order helps you to lock in the profits on your trade, while a stop loss order helps you to prevent complete losses on your trade when the price of the commodity hits a particular price point. When placed well, the stop loss limits the risks on your leveraged positions, as you control how much you wish to lose. Hedging is also something you have to know about.
Hedging positions involve placing opposite trades to counter your losses on a commodity. For example, if you hold a long position on an asset and the trade is against you, you may hedge your position by opening an equally valued short position. Although you need a sufficient margin balance for this, it helps you limit your losses.
CFD trading is a comprehensive mix of investment options, allowing you access to trade on a global array of assets and making a load of money from even a decrease in the asset’s price. Of course, there are apparent risks, but the right tools and strategies exist to help you limit exposure to these risks.