Contract for Differences (CFDs) Trading – An Introduction
Are you just getting into the forex world? Chances are that you want to venture into CFD trading. The only issue here is that you will be taking a risk and you probably don’t know how to go about it. In this article, we are going to introduce you to Contract for Differences so that you are in the best position to approach it with a higher chance of succeeding.
What is it?
Essentially, CFD is a contract between a seller and a buyer stating that the buyer has to pay the seller whatever difference there is between the value of an asset at the time of the contract and the present value of the asset.
Simply put, CFDs offer both investors and traders the chance to earn from the price movement of assets without owning them.
A CFD contract has nothing to do with an asset’s original value. Instead, it focuses on the price movement between trade entry and exit.
How CFDs Work
Just as we have explained, a CFD is an agreement to exchange the difference of a financial product’s value between a broker and an investor. This applies only between the time that the contract begins and ends.
You may want to keep in mind that this is a progressive trading approach that is best used by seasoned investors. With CFDs, there is no delivery of securities or assets. What we are trying to say here is that the investor never owns an underlying asset.
Instead, they get profit (or loss) based on the fluctuation in the price of an asset. For instance, you can predict whether the price of precious metals will rise or fall rather than buy them.
As an investor, you can bet using CFDs regarding the price of an underlying asset. You get to bet on either downward or upward movement. Once you have bought a CFD, and you feel that the price of an asset will increase, you can offer it for sale.
Consequently, the difference between the sale price and the purchase price is combined. After that, the net difference is calculated to get the profit from the trade and then settled via your brokerage account.
Conversely, if you think that the value of an asset will fall, you can place an opening sell position. To close that position, you would have to buy an offsetting trade.
CFDs are Illegal in the U.S.
As much as you want to venture into CFD trading, you want to note that it is prohibited in the US. Why? Mostly because CFDs are an over-the-counter product. What that means is that they do not undergo controlled exchanges.
CFDs could potentially lead to bigger losses and this is something that regulators are concerned about.
Subsequently, the Securities and Exchange Commission and the Commodity Futures Trading Commission prohibits citizens and residents of the U.S. from opening and holding CFD accounts on both foreign and domestic platforms.
How Safe is CFD Trading?
The truth is that although CFD trading comes with its advantages, it can be risky as well, and sometimes the risks can overshadow the advantages. This is mainly because of factors like the necessity to retain an adequate margin, probable lack of liquidity, and poor industry regulation.
Is it Possible to Earn from CFDs?
Yes, you can make money from CFD trading. That said, it is a risky tactic compared to other types of trading. Often, seasoned traders with the tactical acumen and vast experience are the ones that will succeed at it.
Things to Remember
*A contract for differences (CFD) is an arrangement to exchange the value difference of an asset between a CFD broker and trader.
*As a CFD investor, you do not own assets. Rather, you profit from the price changes of the assets.
*With CFD trading, you get access to assets at a reduced cost compared to when you purchase the asset.
*The main disadvantage when it comes to CFD trading is the instantaneous decrease of a trader’s original position that is reduced when they enter a CFD.
The Bottom Line
CFD trading can be a great way for you to earn but it is not an easy market to venture into. Just as it has advantages, so does it have disadvantages and risks. The potential risks are what make it prohibited in some countries like the US.
Ultimately, you are likely to succeed in the trade if you have the acumen and experience required to make correct predictions.