CFD stands for Contract for Differences, and as the name indicates, using this form of trading, traders enter a binding with their broker to sell an instrument at a later date and a specified price. While using CFDs, traders do not have physical ownership of an asset but can make money by going long and short.
To understand the phenomenon, let us consider an example where an investor buys gold at 1500. They hold their position until 1900 and end it when the price reaches the designated point. All the process is digital, and there is no transfer of the actual metal between the two parties.
What are the vital characteristics of CFD trading?
CFD trading brings lots of opportunities for traders. We will go through them so that traders can reap the maximum benefits.
With CFD trading, traders can access as much as 1:3000 in leverage. This is borrowed money from the broker that helps open big lot positions. Once the trade is closed, the brokerage takes back their capital, leaving an investor with the profit or the loss.
A trader using the leverage of 1:2000 has a total buying power of $200000 with a balance of $200. While this may seem catchy, it can quickly cause a margin call on the account.
Forex pairs (GBPJPY, USDCHF, USDJPY, etc.), indices( DAX 30, Dow Jones, S&P500, etc.), stocks(eBay, Samsun, Microsoft, etc.), commodities( Soybean, Crude oil, etc.), and treasuries are all available with CFD trading. Most brokers can list them all under their portfolio, eliminating the need to jump from one exchange to the other or opening multiple accounts.
There are multiple models in the trading costs. The standard employs fees built into the spread(difference between the bid and ask). The ECN model charges a fixed commission on each trade where the spreads are negligible. This is perfect for traders looking to scalp or day trade the market as the execution speeds are high.
To understand the ECN model, let us consider an example of a trader who purchases one lot of EURUSD at 1.25600 with zero spread. They will get the pair directly at the quote’s price and pay a fixed commission that the broker states.
Regulation is one of the most critical aspects of financial markets. Many brokers are subjected to constant check and balance from regulatory authorities to ensure no fraud or scam runs. A few good names of regulators are
- Cyprus Exchange and Securities Commission
- Financial Conduct Authority
- Australian Securities and Investment Commission
- National Futures Association and Commodity Futures Trading Commission
Opening an Account with a CFD Broker
Opening an account with a CFD broker is simple and does not require much time. The steps are as follows:
- Broker. Find a good reputable broker that offers low trading costs and is regulated.
- Opening an account. Signing up requires only a few minutes. It only requires you to enter your email and password. Some brokers may demand additional verification documents due to KYC policies.
- Trade the markets. Traders can put cash in their accounts by using the available methods, including banks/wire transfers, credit/debit cards, e-wallets, cryptocurrencies, etc. It can take a few minutes to some hours for the designated money to appear in the account.
While CFD trading offers many benefits for traders, it is essential not to ignore risk management and psychology. Using more oversized lots can potentially return better profits, but at the same time, it can be detrimental to your portfolio. There should be no role of greed, fear, and happiness while speculating the markets.