Top 5 Things You Need to Know When Trading CFDs
A lot of people when seeing an opportunity to invest their hard-earned money can be very compulsive at times. A wise investor will read the research and engulf themselves in a lot of videos that they think will help them achieve financial returns in astronomical proportions. Not all material out there will be a surefire way of having massive gains but we have gathered some of the top 5 things you will need to know when you start getting into CFD Trading.
CFDs? What are they?
Contracts for Difference or most commonly known as CFDs is an agreement between a buyer and a seller to exchange the difference between the futures market price and its price when the CFD is made without having to actually buy the asset. These assets can be a currency, cryptocurrency, share, commodity, or index. CFD is essentially a contract between two parties to agree with the difference between the opening prices up until it closes. Profits or Losses are determined whenever the underlying assets move based on the position taken. Depending on your projection as to whether you believe the financial asset’s price will go up or down, you may buy or sell a number of units for the particular instrument. You will gain point movement based on the number of units you have traded short or long. Of course, for every point it moves against your projection, you will lose point movement based on the number of units you have traded long or short. This is the reason most traders are very analytical and cautious as such projections might go against them.
What is great about CFD Trading is that it allows you to profit from upward trends as well as a downward trending market.
2. Buying Long vs. Selling Short
If you think that the value of an instrument is about to rise, you may buy long and earn profit from every movement in price it increases. If you think that the instrument’s price will go on a downward trend, you may sell short and profit from that movement. However, If the market does not move in any of the directions mentioned based on your projections then the result will still be a loss.
Most traders go long (a BUY trade) as they buy long positions for indices, stocks, and commodities. They hold on to them for a long period of time or up until they see the market moves in a manner where they can profit from it.
- Leverages and Margins
Unlike traditional markets, CFD trading uses leverage. You are only required to deposit a small percentage of the full value of an underlying instrument of your choice to open the desired position. Doing so will allow you as a trader to gain exposure to the price movements of that CFD instrument you have chosen which may also open a potentially larger position.
In a nutshell, margins are initial deposits required to make a CFD position, and the amount needed depends on the tradable instrument you have chosen. The required margin needs to be in your account before opening the position. It’s expressed as a percentage of the value of the underlying position and it depends on the volatility and liquidity of the instrument being traded.
- The Advantages of CFD Trading
Unlike other traditional markets, CFD trading provides investors with a wider array of options such as commodities, cryptocurrencies, stocks, currencies, and indices. When trading CFDs, investors are provided with much higher leverage compared to conventional share trading and can be offered as low as a 0.20% margin requirement. This means that you will require a smaller amount of capital in order to commence with trading CFDs which leaves you with more room to trade given a smaller amount required.
- The Disadvantages of CFD trading
The risk however is also present when it comes to trading CFDs. The potential losses might even exceed the amount initially deposited in your account. CFD is able to increase your buying power as a trader. However, it may also end with significant losses resulting from you owing money to your broker. Another disadvantage that CFD trading might have is its market’s High Volatility as it can often fluctuate as frequently compared to other markets. Given that the CFD instruments can directly reflect this, it may result in the prices of CFD products moving too quickly from one price to another and therefore it may not be possible to execute an order in between the two prices.