If you have been interested in Forex trading for some time you would definitely see some of the FX brokers suggesting trading CFDs. For beginner traders, it might be confusing and hard to understand. What is CFD and how is it traded? These are the most common questions asked about this topic. In this article, I will try to explain what is CFD, how can you trade with it, what are the advantages and disadvantages and how to make a profit with it and after all should you start CFD trading or not.
What is CFD trading
The abbreviation CFD stands for Contract For Differences. The name itself suggests what the CFD actually means – the trader does not trade with an actual asset he speculates on the price movement of the fast-moving global market, to say in other words he has a contract for difference of the asset’s price. Does not sound that easy? Let me explain it simply.
Usually, trading includes two parties – seller and buyer. For the trading to take a place there should be something that is traded as you cannot sell me something that you do not have. When you are trading Forex you have some amount of money in some currency – for example, 50 USD, with it you buy other currency and when the exchange rate increases you are exchanging it again for USD. The same goes for the stocks or any other trading instrument, you are buying it, waiting for the prices to go up and selling to make a profit. For more clarity lets see CFD Forex example, when trading CFDs on Forex instead of buying and selling actual currency the buyer and the seller are participating in a transaction which is based only on the price movement of the currency rate. If the price will increase during the CFD course the seller should pay the buyer the difference in price. If the price goes down the buyer should pay the seller the difference in price. The price of the CFD is the same as the actual price of the asset that is traded. However, during the trading, an actual asset is not transferred, but just the monetary change in the value.
What can you trade with CFDs
The contract for differences gives you access to a wide range of instruments that can be traded. As trading does not require actually holding the asset traded the brokers have the possibility to offer a big number of various assets.
- You can trade CFDs on Forex. As I have explained in the example above, when trading CFDs on cryptocurrency pairs you are not actually selling or buying the currency but you are speculating with the changes of the exchange rate of one currency against another.
- CFDs on cryptocurrencies – While the trading with cryptocurrencies is happening with the exchanges and requires holding Bitcoin or other coins, one can trade CFDs on cryptocurrencies with the Forex brokers that are offering CFD trading. Some brokers offer CFDs on the major cryptocurrencies such as Bitcoin, Ripple, Litecoin or Ethereum. With some brokers, you can find so-called exotic cryptocurrencies such as Cardano, Dash and many more.
- CFDs on Shares and stocks – Who would refuse to hold the shares or stocks of the companies like Facebook, Apple, Microsoft, and other big firms? Unfortunately, it is not available for everyone, however, one can trade CFDs on shares and stocks. Different brokers offer different company shares and stocks but almost all the big companies are included in all of the lists of trading assets.
- CFDs on indices – You can find CFDs on indices with almost all brokers that present themselves as Forex and CFDs brokers. The indices can be varied as well and represent the USA, European, Asian and Australian markets.
- CFDs on commodities – You can trade CFDs on commodities like precious metals -such as Gold and silver and goods like cocoa, cotton and many more.
As you can see the list of the assets can be very long and very various. It all depends on the broker you will start trading with. Nowadays you can hardly find a Forex broker who does not offer some kind of CFDs. Usually, all of them are offering CFDs on all six classes mentioned above: Forex/Currency pairs, cryptocurrency, stocks, shares, indices, and commodities. The number of CFDs can be different, one broker might be offering over 100 CFDs while the other can have more than 1000. Therefore if you are thinking about starting it you might wonder how can you start CFD trading.
How to trade with CFDs
Trading is trading- does not matter you are trading Forex, buying actual assets like cryptocurrencies or trading CFDs, you need to get yourself educated first. Starting trading without proper knowledge is like jumping into the ocean without knowing how to swim. Therefore the starting point should always be accumulating the knowledge of what is CFD trading, and how you should trade it.
As you could understand CFDs are traded with the Forex brokers. To trade, you need to choose the broker based on the assets you want to trade. Once you have made your choice you simply open an account with the broker and are ready to go. The trading process goes in the following way:
Choosing the market
First of all, as a trader, you need to choose what you want to trade. Choosing trading assets can be a little tricky. Do not repeat the same mistake as many people do. Usually while trading with CFDs traders, especially the beginner ones want to go with something that seems the most profitable for them. However, it is always advised to trade with assets you actually know about. You need to predict the market movement and the price changes of the assets, therefore, choose ones that you are most comfortable with.
Go long or go short
Now as you know what are you trading, the process of trade starts. Here’s how to trade with CFDs. You need to know the current price of the asset you are trading with. The price is in the trading ticket which you can bring up on the trading platform.
Let’s say you are trading with the CFD on gold. When you open the trading ticket you will see two prices quoted, the first one is the sell price (the bid). The second price is the buy price (the offer). The difference between the bid and the offer prices is known as a spread. The price that is given in the quote represents the price of the gold at the moment of the opening the position.
Now as you have the bid and offer prices you need to decide which position you will take if you believe the market price of the gold will go up, you will buy it ( it is known as going long). If you believe in the opposite and think that prices will go down – you sell the market – go short.
Risk management strategy
Trading CFDs contains a high risk, but you can manage it to some degree before you will open a position. This is one of the CFD trading strategies you need to know. Managing the risks can be done by adding the stop and limit orders. It is kind of an instruction you are giving to the platform to close the position once it reaches a level that you have set by yourself. This technique will help you to close the position on losing trades and minimize the losses. Moreover, setting a certain level to stop and limit your orders is free and you can always use it. However, you need to do it before you first place your order or once the trade is open, you cannot apply it after the trading process has started.
Monitoring and closing your trade
Once the trading is started you can track the market prices and see updates about your profit and loss in the real-time, at the same time you can close or add the other trades. When you see you need to close your trade you need to do the opposite trade to the opening trade. Once you have closed it, the net profit or the loss will be realized, the result of the trade will be reflected on your trading account immediately.
Advantages of CFD Trading
Now as you know how to start CFD trading in South Africa or anywhere else in the world you might be interested in what are the advantages of CFD trading and why you should consider starting it.
Wide selection of the trading instruments
The obvious advantage is that with CFDs you can have access to the wide selection of the trading instruments. Due to this, you always have a possibility to start trading with the assets that you are well aware of. For example, if you want to trade CFDs on stocks, you can choose the stocks of a particular company that operates in the industry you know well. If you love gaming and always keep yourself updated what happens in this sector, there is a more chance that you can predict the price changes of this market more, than any other one. In this case, you might want to choose to trade with CFD on Nintendo rather than CFD on Nike or else. The variety of CFDs makes it possible for you to choose CFDs that can be most profitable for you.
Trade without buying
It is arguable if it is an advantage or disadvantage, as it highly depends on the plans and goals of the trader. With CFDs, you can trade assets that you do not actually own. Therefore many of the traders look at it as a disadvantage. However, in my opinion, it can be considered as one of the advantages of CFD trading. Let’s bring an example for more clarity.
One of the trading assets is cryptocurrency. To trade with cryptocurrencies itself means that you need to buy them to start trading with it, if you buy Bitcoin it can be a long term investment as the prices are not that volatile now. Plus if you will have a winning trade you will not be able to win much as there is no leverage on the cryptocurrencies. With CFDs, you have the ability to trade crypto without owning it, have short time trades and use the leverage which will increase your profit. The same goes for all the other asset classes that can be traded.
The leverage is what keeps traders interested in CFD trading. The leverage gives you the possibility to open a position with a small amount of capital. Let’s say that you have USD 100 on your trading account but want to open a position that requires USD 10.000, you do not need to wait until you gather another USD 9.000 to start trading, instead, you can use the leverage of 1:100. To say it in other words, the broker is lending you the money to trade. Hence, leverage makes it possible for you to enter the positions that are larger than your initial deposit money and make more profit with it. However, you should always keep in mind that the leverage works in the other way around, meaning that when you are using it the loss will be more than it would have been if you would have traded with your money only. Due to this risk, many people ask- is trading CFDs safe? When trading there is always a chance to lose a trade, especially when you do not have a clear strategy, or especially when you are a beginner trader. You are only trading safely when you have acknowledged the risks and you are trading with the money that you can lose.
While trading with CFDs you can minimize the risk and use zero leverage especially when you are just starting trading.
When the newbies are entering the CFD trading, they are presented to the leverage of 1:500 and even more, while it is very seductive, you should always keep in mind the consequences that come along with using the high leverage. You should keep in mind that you do not have to use the high leverage and can choose it by yourself according to your capabilities. As you can see, the leverage can be an advantage and disadvantage at the same time for the traders that are not aware of risk factors. What are the other disadvantages of CFD trading?
Disadvantages of CFD trading
CFD trading is one of the low-cost ways to access the markets due to the margin and leverage, which means that capital investment on each trade is lower than in any other cases. Because of this many traders tend to overtrade. Overtrading results in reducing the capital in a way that it is not sufficient to cover losses across the trader’s portfolio. When trading is this cheap it is easy to overtrade without considering the risks of it and in the end, it can cause ruining your financial situation. Therefore, when considering how to start CFD trading you need to be aware of such risk and be cautious.
Long term investing risks
When we are talking about the CFD trading the shorter is the better. You should not hold positions open for a long time. The traders who want to commit to the longtime investments are not advised to trade with CFDs. Holding a CFD open for a considerably long time increases the costs at that point that it would be more beneficial for the trader to have bought the underlying asset.
Another disadvantage of CFD is also connected to having the position open for a long time. While CFDs are good since there are fewer costs such as taxes or hidden commissions, it can get expensive. If you have opened a position for a longer time the overnight financing costs will be applied and will quickly mount up.
Is trading CFDs safe?
After reviewing the advantages and disadvantages of CFD trading you can see that it has a bright and dark side as well. At the same time it offers the great possibility for trading and on the other side, you can absolutely ruin your financial situation if you will not do it right. Honestly, it is up to the trader itself if the trading CFD can be safe or not. However, CFD trading for beginners can be very hard and therefore risky and unsafe. If the trader will use the high leverage, opens too many positions without having the knowledge of how the market works for the instruments he trades with and in addition will hold the position for too long – then obviously CFD trading will not be safe for him. On the contrary – it will be very risky. On the bright side, it is possible to trade CFDs in a safe and profitable way if the risks will be calculated in the right way and decisions will be made based on the analysis.
How to trade CFDs profitably
Being safe is not something that most of the traders want, it can be good for the beginner traders who are concentrated on experience more than the profit. Otherwise, people trade to gain the profit from it, especially if they are trading CFDs for a living. There are certain ways that can help you be more profitable while trading with CFDs.
Concentrate on loses
This is not advice you will hear often when it comes to the trading. But it can be a piece of powerful advice. If you have USD 100 on your account do not concentrate on how much you can profit from it. When you are concentrated on increasing the profit you will be driven to open more positions that promise more profit. However, are riskier. Concentrating on the losses does not mean you should be afraid of opening positions. It means that you should value each dollar you have on your account and try to lose as little as possible.
Set realistic goals
To trade CFDs successfully and stay profitable you should define realistic goals. When you are just starting trading your goal cannot be turning USD 10.000 to USD 100.000. As the first advice suggests, in the beginning, you should be concentrated on managing your loss. This way you will stay in a game longer and with the less loss. After you are comfortable with the CFD trading and can manage your loss well, you can set a goal regarding the profits. It cannot be the 100 percent increase in your initial deposit, you can start with 10% and later if you will continue steadily it will turn to 100 percent
Control leverage and use stops
The ultimate answer on how to trade CFDs successfully would be to control the leverage and never underestimate the power of the stops. When you control your leverage in a correct way you will not allow yourself to set leverage that can ruin your trading account and at the same time, it will make it possible for you to open a trade that would be impossible for you without the leverage. Hence, when you gain the experience in the CFD trading and switch your concentration from “not to lose” to “how to profit” do not refuse using leverage at all, but balance it in the best way possible for your success.
Always use the CFD stops to protect yourself from losing more than you are allowed to. It will be the best for you, especially for the beginning to only lose the money you have initially funded and not the money you have got from the broker through the leverage.
Is it a good idea to trade CFDs?
As a trader, you should decide by yourself is it a good idea to trade CFDs or not. You need to make the decision based on your investment size and capability, your general goals with the trading and your skill of the trading. At the same time, you need to understand your own trading psychology. Trading CFDs are different from trading Forex, cryptocurrencies or the other assets. If you are into the long-time investments it might not be the best idea for you. At the same time, if you cannot give trading enough time to be constantly updated about the market movements it is most likely that it will be hard for you to become profitable with CFDs. If you are searching for the ways to start relatively low-cost trading and do not mind the short-term trading – CFD trading can be really good for you considering the advantages it comes with.