CFD trading may not sound like much at first, but it opens traders up to an entire world of possibility in terms of trading assets and finance. CFD is an abbreviation for a contract for difference. It is essentially an agreement between two parties, usually, a buyer or seller, where the buyer will pay the seller the difference in value between the current asset value (also called closing price) and the asset value as the time the contract was made (also called opening price).
CFD trading works by brokers developing a popular form of derivative, taking an underlying market, and making a new trading instrument. This new trading instrument isn’t bound to the same rules of a spot trading exchange, where traders can only buy or sell an asset that they then own.
Because CFD trading relies on derivatives, new and even exotic trading instruments can be designed. CFDs can be anything but are most commonly traded as forex, stocks, stock indices, commodities, or cryptocurrencies.
With CFDs, the underlying asset isn’t owned and no actual assets ever change hands. Only the base account asset the contract is settled in is ever impacted in any way.
Due to this design, CFD trading doesn’t rely on spot buying or selling to make a profit, and instead is called a long or short position. If a trader uses CFDs to trade a specific market and expects an asset to go up, rather than buying the asset and holding it, the trader would open a long contract at the current market value, and then settle it at a bid price they are comfortable with. Any remaining difference gets booked as profits, hence the name, contract for difference.
Due to leverage or contract size increasing the impact of a CFD’s ability to amplify profits significantly, it also can greatly enhance losses.
Therefore, it is even more critical to employ risk management strategies and take extra caution when trading CFDs. Traders need to fully understand the contract they are entering and all it entails and also be well-versed with risk management strategies to ensure that their positions and capital are properly protected.
Risk management strategies include only wagering so much per position to establish a winning risk to reward ratio, setting stop losses, or even performing technical analysis to get a read on the market before taking an entry.
Successful risk management strategies vary, but the most successful traders never forget them and don’t stray far from their trading plan. It is also recommended to use a trading calculator to prepare each position properly and know exactly what you are about to enter for a contract.
Forgetting a stop loss using high leverage could create a risk of losing it all. It’s important to never forget this critical step. By having a stop loss in mind in advance, once it’s set, you will be less apt to make changes or panic in the moment of strong volatility. Unfortunately, due to the high risk associated with CFDs, they are not always available in the USA.
One of the most glorious aspects of a CFD trading platform over traditional trading platforms is the ability to long and short markets rather than buy or sell.
When buying and selling, there is only the ability to profit while prices are rising. Traditional market traders sell their assets when they expect it to fall in value, then later buy it back when the price has fallen low enough again to become attractive as an investment.
With long and short positions, traders can generate profit from both rising and falling markets, and always be ready for an opportunity no matter which way the market turns next.
Short and long trades can be held simultaneously, at different prices, and with different targets. This also allows for hedge positions and other advanced trading strategies.
The win to loss rate and total profit or loss will ultimately determine if a trader is successful or not. This is why risk management strategies are especially important. Even when things don’t go your way, losses can be minimized and with the right strategy, it would take as many as 100 consecutive losses to fully drain an account.
Leverage and margin trading can enhance the risk associated with these types of trades, however.
Margin and leverage go hand and hand, and they often get confused or are used interchangeably albeit incorrectly.
For example, a 0.01 BTC trade at 100x leverage, would result in a position size of 1 BTC. In USD terms, a $100 trade at 100x would turn into a $10,000 trade.
Leverage on CFDs ranges from 3x all the way to 1000x on more stable forex currencies. This is how traders squeeze out more profit from the normal stable market. Cryptocurrency, like Bitcoin, however, is more commonly traded at 100x due to how highly volatile the asset class is.
All CFD trading accounts will want to keep enough margin allocated to cover all trades, as well as added margin to protect from liquidation in case a trade goes in the wrong direction.
More margin is required for larger positions sizes or more positions overall. If not enough margin is held, first, a margin call will act as a warning. Then, liquidation of all open positions will occur to cover the total margin required to settle all positions. Any remaining margin will be returned to a user’s trading account balance. The reason any trader would want to utilize leverage comes down to profits. Leverage raises the stakes and makes trading high risk and high reward.
When the position is closed, the margin used as collateral to multiply the power of the trade disappears, but the profits remain. It is important to remember, though, that although the profit generated can be extreme, this also means that losses are also multiplied. This makes things like risk management strategies and strategic stop loss placement that much more important and crucial to trading plans.
Now that you can clearly see the benefits that CFD trading platforms have to offer over traditional trading platforms, here’s how to get started. In very little time and only a few steps, you can get registered on a reliable platform, make a deposit, and go from position to profit.
Traders can sign up for a trading platform of a CFD broker that offers a free demo account before beginning to trade on a live account. Registration is simple, takes less than one minute, and offers an easy to use Bitcoin-based trading account. Your trading account balance is denominated in BTC, protected by bank-grade security and other preventive measures such as two-factor authentication and compulsory address whitelisting.
Funding your account is an important step and gets you even closer to diving into markets. It is important to both be comfortable with your first deposit but ensure you deposit enough to avoid a margin call due or falling into a negative account balance. Some platforms, however, offer negative balance protection. You also need more capital depending on the amount of trade volume expected.
Also, keep in mind most CFD brokers include a commission charge on each trade, and others even include a financing or funding fee for keeping CFD positions open using collateral.
Coming up with a trading strategy that brings regular success is much more difficult than it sounds, however, it is possible with time, skill, practice, and expertise. Of course, luck can be a factor as well.
Performing technical analysis to establish a buy price in which to enter and sell price at which to exit is paramount to success. Once a plan is in place, it’s time to take a position.
Prepare the position you want to take by entering the desired entry price. If the price is close, you may want to consider entering the trade immediately through a market order. Otherwise, choose a limit or stop order and submit your order.
When the order has filled, enter a stop loss, and then the final step is next.
All that’s left, unless your stop loss is triggered before this point, is to take profit once a desired level or target is reached.
Taking profit often and even early is recommended. This way if the market turns back the other way, you close the trade in profit and not at a loss.
The two most common ways to trade CFDs is through day trading or swing trading. Both techniques have their own set of pros and cons, discussed below. The same tools and risk management should go into both types of trading techniques despite the differences. These basic building blocks of trading shouldn’t change.
Day trading involves high frequency, short term trade durations often in the same day or trading session.
Day traders prefer the fast-paced thrill of shorter timeframes and more active trading techniques. Technical analysis indicators are the same across both day trading and swing trading, however, day traders focus more on timing, moving averages, or overbought and oversold conditions, instead of trend measuring tools.
The quick, in and out action of day trading is perfect for the speedy contract settlement of CFDs and the platforms offering them. These types of contracts are designed with speed and efficiency in mind. And by getting in and out to rates in rapid succession within the same day or trading session, day traders can avoid overnight finance fees in addition to commissions.
Swing trading focuses more on medium to long timeframes such as daily and weekly timeframes. Typically trades don’t last more than a few weeks and rarely extend beyond two months unless an already open position begins to trend strongly and stops are moved down in profit accordingly.
Otherwise, swing trading takes place at medium-term trend peaks and troughs. Swing trading refers to the more common, buy low and sell high strategy form traditional markets, but medium-term long and short trades through CFDs are also possible.
Some trading platforms may charge an overnight financing or funding fee, in addition to commissions at the time trades are opened. That should be taken into consideration when planning swing trades. Therefore day trading is often considered the ideal trading technique for CFDs. However, this is not a rule and depends on many factors especially personal taste.
Contracts for difference.
A type of agreement or contract where two willing parties, a buyer, and a seller agree to settle the contact based on the price difference between the time the contract was opened and at the time the position was closed. Pricing is based on the market price of the underlying asset of the trading instrument.
CFDs are available for any type of market, from traditional to digital assets. Most commonly CFDs are found across forex, stock indices, commodities like gold and silver, and cryptocurrencies like Bitcoin and Ethereum.
CFD trading is right for anyone, so long as a trading calculator is used so traders fully understand all aspects of their position, including potential profit, the risk to reward, any loss if a stop loss is triggered, and more. Never take position sizes larger than you can stand to risk or lose, and be sure to stick to the trading plan at all times.
Yes, depending on the trading platform selected.
Leverage trading uses margin to use as collateral when taking position sizes much larger than the capital would otherwise normally allow for. This lets traders gear their trades and greatly amplify any profits generated from each position. This also will increase risk so prepare accordingly.
Long and short lets traders profit whichever way markets turn. Long and short positions are just one of the most important benefits of CFD trading.
CFD hedging involves opening a short position in an asset that is also a long term hold as an investment. For example, a trader holds Bitcoin, and both fear a crash is coming but don’t yet want to set until there’s more confirmation a trend change is underway. At the first sign of reversal, a trader can open a hedge short position, and profit from any drawdown before they make up their mind as to what to do with their long term investment holding. It is a great way to protect and even grow capital in the short term during crashes or downtrends.
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