Contract for difference (CFD) trading is a means of trading without actually trading physical goods, stocks or currencies. This type of investment is not about obtaining an asset and selling it later, but more like betting on whether it increases or decreases and profiting on the difference. The movement on the market is where it counts, which is why CFD trading is popular with volatile assets.
It is a relatively new investment concept that came from the 1990s as a technique to trade financial derivatives. There is no tie to any specific market as a CFD is between traders and brokers and typically has lower margins and low up-front investment and low margins.
CFD and Forex
Since there is lots of movement in Forex trading pairs, CFDs are also applicable in this market. You will be buying the currency with the broker and won’t have the currency in your account. While trading at a margin exists with regular brokers, a CFD will likely be more favorable.
The spreads and currency prices are typically arbitrary to the provider and may sometimes have it set in their favor. This is why you should carefully research CFD brokers to make sure you are getting a more fair price and spread. This is especially true with the entry price, as a higher entry price than the market will give you a bigger chance to lose money.
However, once a contract is put in place, maximum trading prices no longer becomes an issue. The goal is to wait for the market price to go above the price locked into the contract. It could also be advantageous to create contracts through a provider in another country, and preferably the country that uses the same currency.
Using a CFD isn’t possible in the United States due to their regulations, but it remains popular in Europe, South Africa, and many other international markets. Generally, the more movement a market has, the more viable the usage of a CFD will be.
CFD and Cryptocurrencies
With the proliferation of Bitcoin in recent years, CFD trading has also transferred over to this market. Cryptocurrencies are unique in the aspect since cryptocurrencies are mostly unregulated while your CFD broker is likely under some sort of regulation.
Bitcoin, Ethereum and new altcoins are extremely volatile markets and may seem some benefit due with a CFD contract. Again, prices may be set slightly lower than market value to hedge losses on the side of the broker, and some fees are involved.
Final Thoughts
Since there are holding fees involved, it should be noted that CFD trading is not suited for the long term investor. In that case, it would be better to purchase your assets the traditional way, although you will need 100% of the money.
Using a CFD as an investment can be powerful for short-term gains and can be used as a hedge against market volatility. Just like any investment, you need market knowledge and a solid trading plan to make money as CFD trading isn’t exactly newbie-friendly.
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