CFD (Contracts for Difference) trading is becoming more popular among experienced investors, although it is open to anyone. Most online Forex brokers offering commodity CFDs are giving options to trade different types of assets using CFDs. It is a potentially high-risk trading method, but you may reduce your risk exposure if you understand how CFD trading works.
Short and Long CFD Trading Explained
You can speculate on price swings in either direction when you trade CFDs. So, in addition to simulating a typical trade that profits when a market increases in price, you may open a CFD position that yields when the underlying market falls in price. In contrast to buying or ‘going long,’ this is referred to as selling or ‘going short.’
If you believe Apple’s stock will fall in value, for example, you can sell a CFD on the stock. You’ll still trade the difference in price between now and when you open and exit your position, but you’ll benefit if the shares drop in value and lose if they rise in price. After the position is closed, profits and losses on both long and short bets will be realized.
Leverage in CFD Trading Explained
Because CFD trading is leveraged, you can obtain access to a large position without having to spend the entire cost upfront. Assume you wanted to open a 500-share investment in Apple. In traditional trade, this would entail paying the whole cost of the shares upfront. On the other hand, a contract for the difference may need you to put up 5% of the cost.
While leverage allows you to spread your cash more widely, keep in mind that your profit or loss will still be based on the total amount of your investment. In our example, that would be the difference between the value of 500 Apple shares from when you started the trade to when you finished it. As a result, both gains and losses can be greatly exaggerated in comparison to your initial investment, and losses can even outweigh deposits. As a result, it’s critical to monitor your leverage ratio and ensure that you’re trading within your means.
Because the money necessary to open and maintain a position – the margins – reflects only a portion of its overall size, leveraged trading is referred to as ‘trading on margin.’
There are two different kinds of margin when dealing with CFDs. A deposit margin is required to establish a position, and a maintenance margin may be necessary if your trade is on the verge of losing money that the deposit margin – and any additional cash in your account – can’t cover. If this happens, you may receive a margin call from your supplier, requesting that you top up your account’s money. If you don’t add enough money to the account, the position may be cancelled, and any losses may be realized.
How to Trade CFDs on the Internet
You can start a CFD (Contracts for Difference) Trading Account with a firm like IG if you’re fully aware of the dangers and want to begin trading online. Opening an account is free; however, each trade will incur a fee in the form of a spread or fee.
These platforms have a minimum contract size for new clients, albeit you will be forced to put down a margin deposit. Trading CFDs can be an effective strategy to obtain exposure to financial markets with less capital once you get started (but more risk). Before making any investment decisions, always seek professional advice.
CFD Trading and Gold Prices
Using gold as an example, we know that demand for precious metals began to plummet in Q4 2017, and prices followed suit. Indeed, gold prices have fallen below $1,250 per ounce, with some analysts predicting that they would fall considerably lower by the end of 2018, maybe below $1,150 per ounce. The expected drop is due to increased investment bond yields and strong tax measures in the United States scheduled for 2018.
It’s evident that gold prices can swing either way, so it’s important to keep an eye on economic statistics, particularly U.S. interest rates, which have a direct impact on gold market prices. You should go “long,” which means buy if you believe gold prices will climb. However, you should go “short” or sell if you think gold prices are more likely to decline.
Traders that correctly predict the market move profit in multiples of the number of CFD units traded. You will lose money if you get it incorrectly, and the price movement goes against you.
Risks of CFD Trading
CFD trading is appealing since it requires a small percentage of the whole value of the item being traded. Trading margins can be as little as 1%, so if you take a $20,000 position, you may only need to put down $200 — not a hefty sum for an armchair investor.
If you have a profit margin, the money you make is based on the asset’s total value. As a result, your profits could soon exceed the tiny margin investment required to retain the CFD. However, if you make a mistake and lose money, you could lose a lot more than your original investment. The primary risk of CFD trading is precisely this. If your positions are still open at the end of the trading day – i.e., held overnight – you may be charged a holding fee. Depending on whatever trading platform or broker you use, there will also be service fees.
Suppose you want to hedge your investments in the underlying shares and assets that CFDs represent. In that case, CFD trading can be a highly beneficial – and successful approach, especially if the market is turbulent. Of course, you can merely trade CFDs on their own as well. You don’t have to have any other investments besides CFDs to use them as a hedging tool. Before you start trading CFDs, be sure you completely grasp the dangers involved.