Contracts For Difference (CFD) is a method of trading where traders buy and sell assets without having to own the asset. CFDs work by opening up agreements with brokerages or other trading institutions and committing money to the contract. Here, you promise to buy or sell a particular asset at a specific price.
To do this, you must pay something called a “margin,” which is essentially your down payment on the deal. The margin size will vary from brokerage to brokerage and can be as little as 5% of the total amount you’re putting in for your contract. Of course, you will lose this money if the asset’s price ends up going against you, and you end up having to sell it at a loss, which is what’s called “settling” on the contract.
An Overview of CFD Trading
CFD trading is an extremely risky method of investing as it relies solely on price fluctuations. Furthermore, it has no underlying value except for what both parties agree upon at the time of their transaction.
CFDs are highly volatile and should only be traded by experienced investors who are comfortable with the risks involved. CFD trading investors use volatility together with the below strategies to place profit-making orders.
Trading Forex volatility
Some of the volatile currencies in the forex market are typically newly introduced futures contracts or pairs with a high correlation. Since currencies do not have an underlying commodity price to draw from, they must rely on other factors for volatility. Some of these include economic data releases, geopolitical events, and widespread world news.
To profit from highly volatile, currencies it is best to trade highly liquid instruments where possible. Currency futures are some of the most liquid in the market, as are currency pairs with a high correlation. Even if they do not have a historical precedent, these types of instruments still offer the most liquidity.
However, CFD investors can also profit from less liquid instruments because they trade on margin. Leverage helps traders amplify their profits, and it is one of the main reasons currencies are still profitable trades.
CFD volatility trading strategies
CFDs employ several different ways. Below are the most popular strategies:
Speculation – CFD traders speculate that the share price or index will rise or fall. They take a view based on a range of factors such as market sentiment, natural supply, and demand or short-term momentum.
Hedging – Many traders have no interest in owning stocks for any period in the stock market. Traders want to be long one currency and short another because they think there will be a change in the exchange rate. Or they may want to be short one stock and long another because they expect that there will be a change in the relative demand for those companies’ products or services.
Arbitrage – Here, you take advantage of an imbalance between prices at two different marketplaces. For example, investors may observe that stock X is trading at a lower price on one CFD broker’s platform compared to another platform. They would then buy the cheaper security to sell it on the more expensive exchange.
Advantages of CFD trading against regular trading
CFDs differ from regular trading by their offer of a relatively new and exciting alternative for traders. The advantage of CFD trading against traditional forms of trade such as stock or Forex Trading is that CFD does not require the trader to buy the underlying asset. As such, you can generate profits without having to own an instrument.
With CFDs, traders’ margins are limited to the size of the margin itself, and a trader can lose more than their investment should they bet wrongly. It is very easy to get hooked on CFD trading because you can use leverage in your trades. You can control a large number of assets by the use of a small amount of money.
Additionally, the range of underlying assets is more significant than in regular trading, and this means that it’s possible to find any number of exciting products. Trading CFDs allows for maximum gains relative to the initial investment. The use of leverage enables traders to hold much bigger positions with less capital.
One of the main differences between investors and speculators is their time horizon. Investors typically have a long-term perspective, whereas speculators trade with a short-term outlook.
However, a growing number of speculators have been getting involved with the foreign exchange market in recent years. In effect, vast movements of currency pairs over short periods are a form of investment rather than pure speculation.