Contracts For Difference — Or Trading Like a Pro With CFDs
The market is one big place, where thousands of traders and companies come together to make money. There is almost nothing in the world of finance that can compare with the power of Forex trade and its $5 trillion daily turnover. As traders venture onto the market, they start learning about the myriad ways that there are out there for making deals happen. The history of finance is riddled with dozens of different types of strategies, and the CFD is one tool that keeps the money flowing.
CFD in details
CFDs, or better known as Contracts For Difference, are one of the types of contracts concluded between two parties on an exchange. The buyer and the seller make up the parties. The contract itself stipulates a simple clause. Under that clause, the seller is obliged to the difference between the present value and the future value of the contract asset in question. The contract term in the future will decide the value of the asset as the contract expires.
The CFD is very popular and is used to trade a huge variety of assets. Given the versatility of the CFD as a type of instrument, it is applicable to anything from commodities and stocks to bonds, currencies and even cryptocurrencies. Like all financial instruments, CFDs carry risk. The risk resides in the omnipresent uncertainty. Given the fact that the CFD foresees a difference in the price between the present and the future, there is always a risk that the buyer of the CFD may be in profit if the value of the asset drops by the contract’s expiry date. Like most instruments used in exchange trade, CFDs do not require the buyer or the seller to actually hold the asset in question stipulated in the contract.
And just like with all other financial instruments, CFDs are subject to a number of factors that determine their profitability. The first factor determining profit will be the size of the lot, or the amount of the asset put up in the contract. It is simply not worth it to for counterparties to engage in trade of small amounts under CFDs. Secondly, given that there are two types of traders on the market — the long and short run traders, it is important to consider which asset is going to be traded under the CFD. If the asset is gold, then long runners are likely to make more profit on the asset, because it is less volatile under standard market conditions. The third and most important factor is that of trends. The trends allow traders to adjust to the market and put up CFDs for assets that are likely to rise in price.
How it works?
Since CFDs exist on virtually every market, including the Forex market, a simple example of CFD trade on Forex would be the British pound versus the US dollar. For instance, a trader is convinced that the British pound will soon be devalued because of the negative news background around the Foggy Albion. At present, the price is 1 GBP = 1.33 USD. The trader sets up a CFD offer for sale for a short position, because he believes the pound will depreciate. The trader turns out to be right in his forecast and the British pound loses 0.0266, or 3% against the US dollar, meaning the price is now 1 GBP = 1.3566 USD at the time of CFD expiration. Thus, our trader is in the plus by 3% and has made a profit. The bigger the lot he has placed — the bigger his trimmings.
Many traders believe that they are pros from the get go, but this is not so. To become a true professional with CFD trade, it is important to practice a lot. It is highly recommended for novice traders to hone their skills in demo trading first before taking on the real market. It is also recommended to take advantage of technical analysis, which will allow the trader to have a broader picture of the market. The graphs and technical analysis will allow the trader to identify trading spots that are in trend and ride the wave of market sentiment. Thirdly, it is extremely important to take appropriate risk management measures when trading CFDs. One strategy is to never risk above 2% of available account balances.
CFD trade is a popular means of making or losing money both on the Forex and other markets. The risks entailed are considerable, but so is the profit factor. The important thing to keep in mind is that the market will determine profit spots, but the uncertainty factor will always trail any forecast, forcing traders to hedge.
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