In this article, we will talk about CFD, the most used way of trading between forex traders. If you are a US trader please read our article about CFD trading in US.
What is CFD?
A CFD or Contract for differences is an agreement between a buyer and a seller to exchange the difference between an asset’s current and future value at a contract time. When you trade CFD you speculate on the markets, without taking ownership of assets. For example, EURUSD forex trading can be an example of CFDs.
It is a way of making profits from the changes in the market price of an underlying asset without actually buying or selling it. Traders or investors get into such contracts with their brokers. There is no actual exchange of an asset; its value is only considered when calculating the price difference.
CFDs have become quite popular amongst traders due to the many benefits they have to offer. Traders do not have to buy an asset, like stocks, bonds, or forex, but have a chance to make a profit out of price movements if it is favorable.
How to Make Money Trading CFDs?
To make money using CFDs you need to risk at most 1-2% of your portfolio, do technical and fundamental analysis, and avoid overtrading.
CFD is a contract between a buyer and a seller, generally an investor or trader and a CFD broker. The broker sells the CFD contract to the trader, which includes a certain asset, but it is only the contract that is sold and not the underlying asset. The contract is then sold at a future date when the underlying asset’s price is more than when the CFD contract was entered, and the trader ends up making a profit.
Making money out of CFD is not as easy as it sounds. Since it is a leveraged asset, a trader must know the dos and don’ts of trading CFDs. For example, it is safer not to utilize the maximum leverage. If you are new at trading CFDs, start with a smaller position.
Are CFDs Safe?
No, CFD trading is not safe because trading is not a safe activity. CFD’s trading is risky trading as same as stocks trading or any other commodity trading. The advantage is that traders can risk only a percent or less of the portfolio at the moment and 99% of the money to keep outside of the risk. However, if you are a gambler or a greedy trader CFD can be a very risky way of trading.
No tradeable asset comes without a risk. Due to market volatility, every asset has a certain degree of risk involved, less or more. The same is with the CFDs. One cannot say that CFDs are 100% safe. There is a certain level of risk involved.
CFDs are famous for hedging, that is, to protect the investment from market volatility. It allows a trader to make a profit on the costly assets that would require significant capital if they buy such assets.
However, there are many risks involved in trading CFDs. There is low industry regulation, and it is also banned in many countries. There is a high chance of a lack of liquidity. Being a leveraged product requires a trader to maintain an adequate margin. Also, since the trading is done on margin, there are chances of faster returns, but also, there are chances that the losses can get magnified.
Is Trading CFD Halal?
CFDs are considered halal or haram, according to Islam law. If traders or investors use non-Islamic CFD accounts that take overnight fees (interest rates) those accounts violate the Muslim sharia law and it is haram. However, if traders use Islamic accounts without overnight fees it is halal CFD trading.
Because of elements like interest, profits, and speculations, without owning the asset, non-Islamic CFDs have a suspicious image under Islamic law. However, all most forex brokers offer Islamic trading accounts that comply with Islamic law. People can open a trading account with such companies or brokerages and avoid violating such laws.
Are CFDs and Options the Same?
No, CFDs and Options are not the same. Both of them are financial derivatives that can be used for hedging investments, and both of them involve a contract based on the future value of an asset. However, their functionality differs in many ways.
In a CFD contract, the buyer and seller agree upon the exchange of the price difference of an underlying asset, from the time the contract was entered to when the position is closed. While in an Options contract, an agreement or transfer of rights is made to trade an asset at a fixed price in the future.
There are other differences between Options and CFDs. CFDs have no expiry date, while Options are time-bound. Due to an expiry date, Options are prone to time decay. This means that options can end up worthless. Such is not the case with CFDs.
What Countries Can Trade CFDs?
CFDs can be traded in all countries except the US. However, all most countries define a list of brokers that are regulated for that country or area. Brokers need to be regulated to work in some countries.
CFDs are not allowed to trade for people in the USA. It is restricted by the US SEC (Security and Exchange). However, non-residents are allowed to trade them. In Australia, CFDs are traded as per the regulations of the ASIC (Australian Security and Investment Commission), which has laid down rules to protect retail clients through reduced leverage.
How Much Does CFD Cost?
CFD trading includes certain costs like the spread, financing, and commission. If you are a trader you need to have a minimum deposit amount that can be from $1 up to $500 as a minimum deposit for some brokers. The trading commission is very low and for some brokers, it can be less than pip. For example, if you buy EURUSD with 1 mini lot, stop loss 100 pips, and target 100 pips you will pay less than $1 commission and you can earn $100 or lose $100.
Commission and financing costs are conditional charges; they are to be paid in certain situations only. A broker will charge you a commission if the underlying assets in the CFD contract are stocks; this is not the case with forex.
A broker may also charge interest if the trader plans to take a long position. If a trader holds a position overnight, it is termed an investment. In such situations, the broker charges interest that accounts for the financing cost for the trader.
Spreads mean the difference between the bid price and the offer price. The buying price of a CFD contract is slightly higher than the asset’s market price, whereas the selling price is slightly lower than the market price. The difference between both buying and selling prices is called the spread. It is the key part of determining both derivative prices.
Can You Hold CFD Long Term?
As there is no expiration of a CFD contract, traders can hold long and short positions as long as they find it feasible. CFDs work better and are aimed for short-term trading because of their low cost and small trends; there are financial costs involved in holding a CFD for the long term.
Since CFD trading involves buying on margin, brokers can charge interest on the long-term holding of CFDs. Long-term holding refers to holding the CFD overnight or after a market session closes. Such holdings are considered investments. Therefore, it may incur some financial charges that a broker may ask from the trader.
Can You Make a Living From CFD Trading?
Yes, traders can live from CFD trading but only if they have a large amount of money. Traders that have more than $100 000 capital can live as CFD traders.
Like many assets available for trading in the market, CFDs can also help one achieve better profits. However, it requires excellent skills and knowledge due to many underlying risk factors. It is a great tool for hedging your investments, but that does not make it any less prone to risks that may include magnified losses.
CFDs are leveraged products, which may give you better and quick profits, but the risk factor is high. It is advisable to start with short and little investment, practice, and understand the concept of trading CFD before going long.
How Do You Profit From CFD?
A trader makes a profit by trading CFD if the difference between the closing and opening price of the contract is positive. That is if the price when CFDs are sold is more than the price at the time of purchase. It is more like speculation, and precision can be attained by knowledge and skills.
To make a profit out of trading CFD, it is essential that a trader must have trading knowledge and skills and must gain experience by practicing the trade. They may also form proper strategies and CFD trading plans based on their knowledge and expertise.
A trader must keep a few things in mind while trading CFD. Since it involves leverage and margins, traders must ensure they are not overused or used incorrectly. Overtrading is a big no for CFD trading because of the potential risk of magnified loss. Also, all the risks should be taken care of along with proper money management.
Why CFD Trading is so Popular?
CFD trading is popular because:
- Very low commission. If you buy EURUSD with 1 mini lot, stop loss 100 pips, and target 100 pips you will pay less than $1 commission and you can earn $100 or lose $100.
- High leverage
- Small deposit amount. You can start trading with $50 or $500 or more without problem.
- Easy to use trading platforms as Metatrader
- A lot of books and tutorials
CFD trading is popular for many reasons. One of them is that traders profit from trading assets without actually investing in them, which would otherwise cost a large chunk of their funds. Also, the leverage involved is higher as compared to traditional trading.
There is no limitation on the assets included in a CFD contract. It gives a trader access to trade on global markets from a single platform. As many other markets do, it does not obligate the trader to buy the stocks before selling them short. There is no requirement to maintain a minimum capital for day trading, and traders get to choose from financial instruments to trade from, like commodities, indexes, stocks, stocks, and sectors.
Can You Spread Bet Without Leverage?
Spread betting means speculating on the movement of an asset, if it will rise or fall, without actually buying such assets. This can be done through leverage, which forms the core of spread betting. Without leverage, the chances of making a profit from incremental ticks become less frequent. This makes the concept of spread betting less enticing and less productive.
The idea behind leverage is that if the trader ends in a profitable position, it will be more beneficial than a straight transaction, as they invest limited funds. The spread bet works similarly and aims to make a profit through future price differences of an asset without investing in it. It is evident that the risks involved are higher due to market volatility, but so are the chances of profit.
Without leverage, a spread bet loses its core essence.
What is the Best CFD Trading Platform?
According to many leading financial magazines and institutions, Interactive Brokers has remained on the list of top CFD trading platforms. The platform offers CFD trading at a low cost and is transparent about its terms and conditions. Other platforms that traders can consider are Capital.com, eToro, and XTB.
CFD trading can be considered the most tricky market of all. Therefore, it is crucial to determine all the market aspects, like the benefits offered by one CFD trading platform that others do not provide. Other considerable factors in choosing the best CFD broker include a list of product selection, CFD fees, options for withdrawals and deposits, and more.