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Things need to know about CFD trading

Contracts for Difference are a trendy investment option. Today, traders in Nigeria use advanced technical platforms to capitalize on movements in the global markets. A CFD is tied to an underlying asset, and pricing is all that matters. Here are the key things to know before delving into live trading.

Definition of the Instrument

Investopedia defines a CFD as ‘a financial contract that pays the differences in the settlement price between the open and closing trades’. It is an agreement between the broker and its client. Its subject is the gap between the entry and exit prices. If you can sell for more than you paid, the trade brings a profit.

Like futures, CFDs are derivatives. This means they are linked to certain assets. However, unlike futures, there is no expiry date or physical delivery involved. This instrument is entirely virtual, and it is bought and sold online.

Pros: Indirect Speculation

Movements of CFD prices mirror the dynamics of the underlying assets. For instance, the value of CFDs on the S&P 500 rises and falls in line with the index itself. This means you may profit from the market indirectly.

In this regard, the instrument is hassle-free. In addition, you may diversify your portfolio. Owners of stocks may also invest in CFDs on the same equities, and profit both ways.

Pros: Going Long or Short

CFDs can be bought or sold via long and short positions, respectively. Generally, buyers hold on to their CFDs, waiting for the price to jump (hence, their position is ‘long’). In reality, due to the increased volatility of the market, this waiting period is brief. On the other hand, traders who expect the price to slump short-sell their instruments.

A savvy trader can anticipate uptrends and downtrends, capitalizing on both. This is an important advantage of CFDs in comparison with other instruments. Risks can and should be managed via stop-loss orders. This feature is familiar to any Forex trader. It allows you to reduce potential risks to a certain level.

Pros: Unlimited Access

If you are familiar with Forex trading, you may have used platforms like MetaTrader 5. Such environments are packed with graphic aids and other features that facilitate analysis. They also allow you to manage more assets, thereby diversifying your portfolio. The same system may be used for currencies, CFDs, stocks, etc. Such is the MT5 platform offered by ForexTime. This company educates clients on what is CFD, and what strategies are feasible.

This system exists in three forms: as desktop software, an app, and a web-based platform. This means it is always on hand, wherever you are. Cloud-based storage allows data to be shared instantly. Thus, you may open a trade from one device and close it via another. The online version is accessed from popular browsers, so no downloads are required.

Pros: Wide Array of Assets

CFDs may be linked to different underlying assets. Different brokers may offer a different choice. For example, the ForexTime broker has:

  • CFDs on stocks of the largest corporations like Apple;

  • CFDs on commodities (e.g., gold or crude oil);

  • CFDs on market indices like GDAX or ND100m;

  • CFDs on cryptocurrencies like Bitcoin.

These derivatives follow the same logic whatever they are linked to. They gain or lose value depending on the movements of the asset concerned. For instance, as crude oil becomes more expensive, so do related CFDs.

Cons: Risks Due to Leverage

CFDs are leveraged financial instruments. This means you may trade higher volumes than you could afford. The broker lends you funds according to a certain ratio. For instance, 1:100 means that you may initiate a trade for $50,000 having just $500 in your account. The conditions depend on the broker and type of CFDs. The scheme is also referred to as ‘margin trading’, where ‘margin’ is the required size of your investment.

It is the leverage that makes CFDs so attractive, but it can also be dangerous. In finance, there is no such thing as a high return — low-risk product. The correlation between risks and potential gains is linear. The more you put at stake — the more you could lose. Therefore, leverage requires caution. A single misstep may leave you empty-pocketed.

Cons: Danger of Overtrading

All too often, CFD traders take action when they really shouldn’t. The trading of this instrument is quite fast-paced, and it is easy to get carried away. Overtrading is a common rookie mistake. Your every move must be based on a calculated analysis of the market.
Emotional control is vital. Avoid opening positions based on hunches. If you are depressed or overjoyed, refrain from trading until the feeling passes. Otherwise, you risk taking the wrong steps that will eat at your deposit. If your trades are leveraged, blunders may wipe it out completely.

Cons: Financing Fees

Some (but not all) CFD brokers charge a commission if you do not open and close all trades within the same day. These are known as overnight fees. Find out if your provider has such conditions. Usually, this is typical for leveraged and short positions.

The Bottom Line

CFDs are virtual derivatives traded through advanced trading terminals. They are highly leveraged and allow skilled traders to make high profits. In this volatile market, you can open either long or short positions depending on your view of future trends. CFDs are a flexible trading instrument.

CFDs must be treated with caution, as losses are magnified by trading on margin. This is attractive but also dangerous for novices. Develop a solid strategy in the demo mode before venturing into the real market. Remember: its forces are beyond your control. You can only foresee their direction.

Shady brokers are always willing to offer newbies impressive leverage. They know their clients will eventually lose their deposits. They will not bother matching your trades either. It is vital to ensure that you are working through a reliable and regulated broker authorised by such organisations as the FCA.

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