What Is CFD Trading?
CFD, or Contracts For Difference, is a type of financial contract in the derivatives market in which two different entities (trader and broker) enter into an agreement to exchange the differences in the price of an underlying financial asset between its opening and closing prices. Essentially, these two different entities are taking a trade against each other such that the difference between the opening price and the closing price of a contract determines the ultimate winner of the trade.
CFD trading involves opening a contract in a wide range financial markets that include stocks, commodities, indices, shares, currencies, treasuries, bonds, and other similar financial assets. CFD trading is highly speculative in nature, and a CFD trader can go long (buy) or short (sell) on an underlying asset according to his market sentiment. If a trader expects the stock to rise, he can buy the asset at a predetermined price and make a profit according to the movement of the market in his direction. The converse applies to a down market where a trader can profit from a stock that is going down according to his speculation.
CFD trading is a leveraged product that offers an enormous amount of margin. Therefore, traders can invest in the markets with a comparatively modest investment capital, and the profit or loss of a trade is determined by the investment capital and the per point cost of the financial asset. A CFD can be opened and closed at any specific price point, and the trader has the freedom to manage the trade according to his preferences.
How Is CFD Different From Forex?
CFD has many similar traits of Forex trading. Forex trading involves buying or selling a currency pair according to the market price and making a profit when the trader has made the right call in the movement of the markets. The same rule applies to CFD trading as well in which the trader profits from a trade that moves in the direction of his trade.
However, the core difference between CFD and Forex lies in the sheer number of financial assets available for trading. Forex trading only deals in currency pairs, while CFD trading involves trading a comprehensive set of financial assets from markets around the world. CFDs also offer currency pairs as an option, which is why CFD continues to grow in popularity among all types of retail investors.
The margin or leverage in Forex is calculated using a ratio system such as 1:100 or 1:500, while the margin in CFD is calculated according to a percentage system such as 10% or 25%. All trades in both Forex, as well as CFD trading, are executed in a similar manner, and the only difference is the cost of trade which differs in Forex when compared to CFD. A trader makes or loses money in both types of trading according to the point or pip change in the underlying asset or currency pair.
There is also a difference in the way traders invest money into both of these markets. In Forex, the trades are opened in multiples of a standard lot or a mini lot according to the type of trading account, while CFD trading involves trades in multiples of a single contract. Forex traders usually have the freedom of investing and trading currency pairs using any base currency such as the USD and the GBP, while CFD trading necessitates the need for investing in the base currency of the contract being traded. For instance, trading the S&P500 might require the trader to trade using the US Dollar as the investment currency, while the FTSE 100 index can only be traded using the GBP as the base currency.
So, Can Forex Be Considered As A Part of CFD?
Some traders believe Forex to be a form of CFD, but they do have integral differences in the way trades are opened, and profits are distributed to the trader. Both Forex, as well as CFD, trading does not allow the trader to own the underlying asset, unlike orthodox forms of trading the financial markets. CFDs are dealt in contracts and can result in losses that are greater than the initial deposit. CFD and spread betting are two financial markets that can result in a negative balance, and this is due to the high leverage available in the markets along with the risky nature of the investment. Volatility in the markets can also determine the outcome of the trade, unlike in Forex where there are mechanisms in place to stop out of trades using margin calls that prevent any instances of a negative balance.
What Moves The CFD Markets?
CFD contracts involve financial assets that are governed by several geopolitical and economic factors that can potentially drive the price in both directions. A news event, macroeconomic releases, company financials, income statements, and even speeches delivered by key industry figures can influence the price of assets by a hefty margin.
Unlike the traditional markets, CFD trading allows a trader to either buy or sell an asset to make profits based on the existing market conditions. Such types of freedom and flexibility can ensure that the trader can interact with the markets without actually owning the underlying stock, thereby reducing market exposure. Trading on margin also helps a trader to minimize the amount of capital risked in the market, which can help the trader to conserve his trading capital to a greater extent.
Trading CFD at a CFD Broker
Several brokers offer the convenience of trading Forex as well as CFDs through a single brokerage account. The ease and simplicity of CFD trading and its resemblance to Forex trading have enabled companies to include CFD as part of their service portfolio. At Binary Options Trading, we provide you with a list of approved and regulated CFD brokers that are regulated as well as commended for their services and performance in the industry.
CFD trading is a leveraged trading instrument that carries a high amount of risk. The trader can lose his entire deposit and have a negative balance if he is not careful with the leverage and his money management strategies. While choosing a CFD broker, a trader should always consider his risk appetite and the reliability of the broker to ensure that he doesn’t owe the broker anything in the event of a losing streak.
CFD Trading Platforms & Associated Trading Costs
CFD trading platforms are similar to Forex trading platforms, and traders can invest their money in CFD through the desktop or mobile trading platforms. Most of the CFD platforms have inbuilt trading functionalities that help a trader to perform extensive technical analysis on an underlying asset, and also enable him to manage his trades within the interface.
The pricing structure of CFD trading is different from Forex trading. Forex trading works on a spread related pricing structure that is incurred on every trade. The spread is the difference in price between the ‘bid’ and ‘ask’ rate. ECN accounts also typically involve a commission per trade, and all overnight trades are associated with SWAP or interest rates. CFDs trades only include a commission per trade that can vary according to the underlying asset, and is usually lower than the fees charged at the respective stock markets. CFDs are relatively more economical to trade than traditional stocks due to the far lower costs involved in opening and closing trades. Due to CFD being a leveraged market, all overnight trades also accrue a SWAP or interest per traded contract.
CFD trading can be considered as a good alternative for traders who do not want to risk the costs and long-term implications of being invested in actual stocks, indices, or bonds. While it is true that traditional investments can also lead to supplemental revenue such as dividends, it does not make sense from a short-term perspective of a day trader whose sole intention is to take advantage of the fluctuations in the price happening on a daily basis. CFD encompasses a wide array of financial instruments that allows a trader to diversify his investment portfolio. CFD has indeed become one of the most popular choices when it comes to trading the financial markets due to the freedom it offers to the informed retail trader.