Introduction
CFDs involve speculating on financial instruments without having their physical ownership. This form of trading allows traders to place both sell and buy positions and use multiple orders types to hedge their trades or use averaging.
CFD stands for Contract For Differences. As the name indicates, the trader trading on CFD instruments enters a contract with their broker that allows them to exchange the difference in the value of the assets at the time of opening and closing. An investor may have to pay a fixed cost or spread for opening positions, i.e., the difference between the bid and ask price.
What are the basic characteristics of CFD Trading?
To take full benefits from CFD trading, traders must understand a few vital characteristics.
Cost Structure
As mentioned before, trading CFDs traders will have to pay a fixed commission or spread. The prior model is used in ECN accounts suitable for scalpers or day traders, while the latter is better for swing traders. Swaps are applicable for trades held overnight. Islamic accounts do not have to pay rollover fees as the sharia prohibits it.
Micro and cent accounts offer minimal risk for traders as the account balance, and the lots are measured in cents. Demo accounts are available for those who want to trade risk-free.
To understand the concept of spread, let us consider an example of a trader who places a buy trade on GBPUSD at 1.14560 with a difference between the bid and ask of 1 pip. They will get in on 1.14570 and will have to go above this price for the trade to be in profit.
Instruments
Stocks, forex, indices, futures, etc., are all available with CFDs. Brokers can list them all on their platform so that traders do not have to shift from one exchange to another.
Trade Direction
As mentioned before, traders can speculate the market on both the long and short sides. This can help them hedge out of the buy positions and vice versa. It also opens the door to multiple martingales, grid, and hedging strategies.
Leveraging
CFD brokers can offer unlimited margin to traders. Leverage is borrowed money that can be used to open positions with big lot sizes. After the trade is exited, the loan is returned to the broker, and the trader keeps the profit or losses. It is vital not to exceed the leverage value on your account as it increases the risk value.
Capital
With CFD, trading traders can open up accounts as low as $1 in value. The meager requirements minimize the risks and, at the same time, allow investors to get a taste of the real market conditions. This can be a good option for testing algorithms.
There are also a variety of orders at the disposal of a trader. This can include stops, GTC, limit, etc.
Regulation
Financial regulators keep an eye on CFD brokers and ensure that they are treating the customers properly. Traders can check out if a broker is regulated by visiting their website or contacting one of the regulators.
Disadvantages of CFDs
Let us discuss some drawbacks of CFDs:
A high spread with a CFD broker can wipe out most of your gains. Traders can use cashback offers that help them get a portion of their fees
Offshore CFD brokers that are not regulated by any financial authority can possess a risk
CFD trading does have many opportunities for investors. Traders will have to understand the importance of proper strategy and risk management. Trading psychology can play a crucial role here where the implementation of greed and fear can cause potential loss of capital.
