Among the number of financial assets, there are two fundamental types: real assets and derivatives. Real assets, such as shares, commodities, or currency pairs, are tangible and have real value. Conversely, derivatives are contracts confirming the right to do something with real assets (usually, sell or buy). Derivatives include options, forwards, CFDs (contracts for difference), and a few other types. This article will discuss CFD meaning in Forex and the best practices of trading.
What are CFDs (Contracts for Difference)?
A contract for difference is an agreement that gives its holder the right to sell or buy the difference between a present price and the future price when a contract is closed. It is always tied to an underlying asset but doesn't entitle you to owe this asset.
What are CFDs in Forex?
Forex CFDs allow trading currency pairs without owing them. It means that if a trader buys a CFD and the price moves in the right direction, they can take the price difference. They didn't owe any currency either before or after the trade, but the CFD allowed them to make a profit from this fluctuation.
CFD vs. Forex: What is the difference?
The difference between CFDs and Forex is simple. Forex prescribes owing some currency to make orders. Here is a CFD Forex example: if you have some amount of US dollars and think that the pair EUR/USD will go up, you can buy euros now, as in the future, they will be more expensive.
If your prediction is precise, you’ll take a decent profit that depends on your bid. However, you won’t be able to do anything on this pair if you don’t have dollars on your account. Contracts for difference give you an opportunity to make a profit without owing these currencies. Though, losses are always possible. The thing is that the game concerns only the price difference, not the asset’s whole value.
CFD Trading on Forex
What is Forex CFD? It is quite similar to regular FX trading. In fact, you also earn on price fluctuations. You utilize the same technical analysis tools and apply similar strategies. The difference is that you actually don’t owe these currencies at any moment. Despite many similarities, there are some nuances that should be kept in mind. It is important to know all the advantages and risks of CFD Forex trading before investing real money.
Advantages of CFD Trading in Forex
The list of advantages of CFD on Forex is quite impressive. It comprises high leverage, trading in both directions, access to the market without high investments, trading 24/7, and several others. Let’s take a closer look at them:
- Leverage means that you can make trades significantly bigger than the amount of money you actually possess. It is usually depicted as a ratio: 20:1, 30:1, etc. This means that you can open positions that are twenty or thirty times bigger than your initial capital. This is an essential concept for CFD FX trading, as it allows for amplifying profits with a relatively small deposit.
- Trading in both directions. When you trade a currency pair (e.g. EUR/USD) and you owe US dollars, you can only sell them. That means you'll open a position only if you expect a downtrend. CFDs allow you to speculate on both rising and falling prices. Depending on your expectations, you may open either a long or short position. "Long" and "short” are terms that describe what you do with a Forex CFD contract. Going long means that you buy and expect a bullish trend. Conversely, opening a short position will bring you profit in case of a bearish curve.
- Trading round the clock is another advantage of CFDs. It is well known that Forex works only five days per week and is closed on weekends. Nevertheless, contracts for difference are available throughout the week. While CFD price fluctuations in working days are tied to markets, trends are more dependent on traders' sentiment on the weekends. If you tend to scalping or daily strategies, you don’t have to stop trading when markets are paused.
- No ownership is needed. The last but not least advantage of CFDs over Forex. Traders do not have to own all the currencies they want to make money on. Still, they can earn on major, minor, and exotic pairs with the help of contracts for differences. This opens great opportunities for hedging and other risk management techniques.
Risks and Considerations
Risks are a natural part of trading. It is reckless to engage in financial operations unless you have a proper risk management system. This is especially true for CFD in Forex. Why is it so? The reason lies in a leverage mechanism. It is great for magnifying profits, but it can amplify losses as well.
To avoid quick depletion of your deposit, it is necessary to take appropriate precautions. First of all, when opening a position, traders should set a stop-loss. It will prevent huge losses in case the price changes in an unfavorable way. These orders are executed automatically in all trading programs like MT4, MT5, and others.
Simultaneously with stop-losses, it is recommended to set take-profit orders to lock in your earnings and withdraw them before the trend changes.
Among other issues to consider when Forex trading CFDs are possible slipperies. These are the difference between the price on closing the order and the actual amount of money a trader gets. This happens due to the high volatility of the Forex market: in several seconds, the trend can move for several pips.
For proper risk management, it is also important to diversify assets in your investment portfolio. Choose several pairs to reduce the impact of negative market factors.
Last but not least. The trading strategy is not supposed to be a risk-management technique, but the negligence in its execution jeopardizes your deposit significantly, On the other hand, the consistency of your trading solutions can significantly reduce the risk of high and sudden losses.
How to Get Started with CFD Trading on Forex
It is not difficult to start CFD Forex trading. You’ll need to take several preparatory steps and then begin your trader’s journey. Check out these step-by-step instructions:
- Step 1. Select a Forex CFD broker. There are literally hundreds of brokers worldwide. However, not all of them offer the best service. Do research, read reviews, and forward your questions to a support service. Once you have found a broker that suits your needs, move on to the next step.
- Step 2. Open an Account. To do this, you’ll have to enter some personal information. This will include your full name, home address, date of birth, and contact details. Make sure the information is correct.
- Step 3. Confirm Your Identity. Before you can deposit funds and start trading, you need to verify your identity. The way of doing this can vary for different brokers, but usually, the verification process is very simple. In most cases, you will need to upload a copy of your passport or driver's license, as well as proof of address.
- Step 4. Deposit Funds. Once your identity is confirmed, you can fund your CFD broker account.
- Step 5. Start Trading. Now, you can explore huge opportunities in CFD trading. If you are not confident in your skills, you can try the best Forex robots for professional and profitable assistance.
CFD Trading Strategies for Forex
Developing a strategy is a creative part of CFD trading. Even if you find guidelines with dozens of different strategies, your own will be still unique. The way you trade depends on your personality, risk tolerance, and many other factors.
Let’s look at an example of a strategy that is commonly utilized for CFD trading. For example, day traders can use five-minute charts and make four to five trades in a single trading day, with each trade remaining active for approximately thirty minutes.
CFD Forex Trading: Practical Tips and Techniques
For Forex CFD trading to be successful, it is extremely important to prepare for trading. Pay attention to these four small tips that will help you successfully cope with problems and make a profit.
Tip 1. Stick to the strategy
Develop a clear strategy that is based on straightforward rules. Do not improvise while trading. Your emotions will hinder you from optimal solutions, so it is better to be persistent when executing your plan.
Tip 2. Use a moderate leverage
Large leverage is very tempting as it gives an opportunity for a big win. However, risks also increase gradually. When trading CFDs Forex, it is not recommended a leverage of more than 10:1. This is an optimal value that allows a trader to maintain a balance between high rewards and acceptable risks.
Tip 3. Always set a stop-loss
The market can change very quickly. That is why it is necessary to set automatic orders that will protect your funds. Every trading software has this option, so don’t start trading before you learn the basic technical tools.
Tip 4. Research the market
Trading contracts for difference has its specifics. If you have experience in the crypto market or indices market but not a Forex CFD market, you definitely need to do proper research. Explore charts on different timeframes and learn the main technical indicators. Only then can you start trading CFDs.
The Bottom Line
CFD FX trading offers good opportunities for profit. However, CFDs also pose a significant risk that you should consider before opening a position. A trader needs to conduct a detailed market analysis and be cautious before investing their money. It is equally important to choose the right broker that offers good risk management features, a wide selection of CFDs, and competitive commissions. By choosing a reliable broker and an effective strategy, you significantly increase your chances of success.
