CFD trading allows an investor to postulate on market fluctuations as the prices rise and fall. These markets include cryptocurrencies, as well as currency pairs and other asset types. Instead of buying the asset itself, the investor tries to predict the price movement of the market.
Forex is one of the myriads of markets that you can trade on. If you plan to trade Forex CFDs, you must first study the underlying Forex currency pairs. Contracts for Difference (CFDs) are simply an additional method of trading Forex.
Learn the Forex Quote
A Forex quote is made up of two currencies:
- The base currency
- The quote currency
The pair may mirror the strength of one currency against the other. The exchange rate is based on the relationship between the economies represented. Before trading on a currency pair, you must be aware of the political and economic events that may affect each currency.
You do not want to trade on a currency that may go awry because the economy is undergoing a political upheaval. Political instability can have far-reaching effects on a country’s currency. Once you understand the basics of a specific currency pair, then you can learn more about the workings of CFDs.
A Comparison of Forex and Forex CFDs
Forex trading involves exchanging an amount of one currency against another currency. The investor seeks to profit from purchasing one currency in the hope that it appreciates against the other. If the exchange rate falls instead, the trader makes a loss.
This one lets you leverage your trades on currency pairs through speculation of the market movement. Therefore, you will not put up a set amount of funds. Instead, you put up some money and profit from the difference between the opening and closing price of a pair.
Leveraging makes it possible for traders to increase the size of a trade. Since you are only expected to pay part of the amount, you have some funds left over for additional investments. However, you must also be aware that you stand a chance of making a loss.
If your speculations fail to pay off, then you will make a loss. Nevertheless, trading comes with a certain amount of risk. There are tools you can use to mitigate the risks.
Risk Management in CFD Trading
While you can make great profits in CFD trading, you also stand an equal chance of making losses. Leveraged CFDs are actually risky compared to trading the underlying asset. However, there tools available that you can use to manage your risks.
These include the following:
- Closing a trade when it reaches an established level of profit
- Close at loss: This allows you to place a limit on risk to a certain value
- Guaranteed stop
- Trailing stop
Risk management is important in any form of trade. You must always remember to only trade with money that you are comfortable losing. It is not wise to put all your money on a trade.
Futures Contracts vs. Contracts for Difference
You can trade Forex as CFDs or as futures contracts. There is, however, the need to understand the differences between the two. For instance, while CFDs are an over-the-counter sort of trade, futures are traded on exchanges.
Futures have an expiry date. You have a contract to purchase or trade an asset at a set date at a fixed price. CFDs have no expiry date. You are allowed to close at any time. Note that CFDs are short-term products based on speculation. They are not intended to be held for a long period.
Transactions in futures contracts have the broker acting as a go-between. In contrast, the broker in a CFDs trading transaction is the counterparty.
The trick is in being fully informed about how CFD trading works. Remember that you must have all the information you need about the economies represented by a currency pair. Certain events in a country will have far-reaching effects, be they negative or positive, on their respective currency.