CFD trading: a beginners guide
CFD trading involves speculating on the price movements of an underlying financial asset. Tradable assets such as individual company stocks, commodities and indices are available as CFDs and a trade is based on the difference between the entry and exit price.
If you are trading a stock CFD you can trade at any time of the day and your aim is to correctly predict whether the stock’s price will rise or drop. You simply buy a contract which mirrors the current price of the company’s stock – if the stock starts climbing you profit, assuming you get out of the trade while the market is still moving upwards. The same applies for all CFD trades regardless if you are trading stocks, cryptocurrencies or gold etc.
Online forex trading follows the exact same principles and therefore all forex pairs can be traded as CFDs without actually owning any of the underlying currencies.
Why trade CFDs?
The CFD market is particularly popular with retail traders mainly due to the following reasons:
- Short-term opportunities for profit around the clock
- CFDs are traded on margin which can be used to buy larger contracts than the initial deposit can afford and therefore increasing your profit potential. If used sparingly, margin trading can be invaluable for traders but excessive used of margin increases your exposure to risk many times over.
- Access to a diverse range of tradable markets including Apple, Google and Amazon stocks, cryptos such as Bitcoin, Ethereum and Ripple as well as precious metals such as gold and silver.
- No commissions aside from the spread which is a small fee paid to the broker for each trade. However, each broker may offer different prices depending on the instrument. If your strategy dictates that you open several positions throughout the day, it’s crucial that you find a broker with competitive rates.
- Ability to profit from a negative market climate. If the price of the underlying asset is declining, CFD traders can sell instead of buying a contract and still make money considering the asset’s value remains below the entry price.
How to trade CFDs
Learning how to trade CFDs successfully is a painstaking endeavor, but opening a position on your trading platform can be done by following these simple steps:
- Select the symbol/asset or currency pair you wish to trade. In forex trading, the most traded currency pairs, which are the ones who move the most and therefore considered the most profitable are the EUR/USD, GBP/USD, AUD/USD, NZD/USD, USD/JPY, USD/CHF and USD/CAD.
- Then you need to select the volume of your trade. Forex brokers offer standard lots which are the equivalent of 100.000 units of a currency down to micro lots or 1000 units.
- Choose a stop loss and take profit target. These optional parameters are critical both in terms of protecting your account from unnecessary losses and guaranteeing some profit in case the market moves against you unexpectedly. As soon as the asset’s price hits any of your predetermined targets, the trade will be closed, and your account balance will reflect any profits or losses incurred.
- Select Buy or Sell depending on the direction you believe the market will move towards. For example, if you are trading the EUR/USD and you believe the euro will start increasing in value, you would buy – otherwise you should sell in order to profit from the downwards movement.
- Close the trade at any time manually to realize any potential profit or wait for your stop loss or take profit orders to be activated automatically.
CFD trading caveats
While trading CFDs can be very advantageous for retail traders looking to take advantage of movements in exchange rates, it’s also a very dangerous environment for beginner traders due to high risks involved.
As already mentioned, trading on margin can magnify your profits, but at the same time, it also increases your risk exposure and usually, you don’t have the option to forego this leverage entirely. If you want to minimize your exposure to the market you can, however, reduce the volume of your positions.
Another double-edged sword in CFD trading and forex trading in particular, is the vulnerability of the market to external geopolitical turmoil and other events. Supply and demand as well as investors’ confidence in the market is fleeting and a financial announcement can effect increased market volatility causing prices to move rapidly and unpredictably in either direction.
The majority of forex and CFD traders, prefer the inherent volatility of the market because fast moving prices return higher profits. However, conservative investors should note that trading forex and CFDs becomes increasingly risky during important market events and financial announcements. Succeeding in trading is all about protecting your investment and this should be your top priority at all times.
If you want to expand your knowledge about CFD trading and access our latest educational training videos and on-demand webinar presentations, please visit our Education Center.