CFDs are very popular trading assets, which offer traders the ability to trade different types of instruments without owning them directly. Short for Contract for Differences, CFD represents an arrangement between a broker and a trader about the possible price movement of a certain asset. These contracts can be used in many different markets, including commodities, cryptos, stocks, and many others. By speculating on the possible price movements in the market, you are not buying or selling any assets when you trade CFDs.
You are simply opening a contract saying that a certain asset is going to either decrease or increase. However, there is much more that goes into trading CFDs. It is a huge market and there are millions of people who are attracted to it. So, let’s discuss the real CFDs meaning and see how this market actually works below.
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What is CFD and How Does it Work?
As we have already said, CFD stands for the contract for difference. It is a type of contract that is made between a broker and a trader where two sides agree that until a predetermined time, the price of an asset is going to reach a certain point.
As a trader, if your claim is true at the time of the deadline of the contract, you end up making a profit. However, if your prediction was wrong, you will be losing the position. For many traders around the world, CFDs are a perfect way to invest in different types of markets.
The best thing about CFDs is that you can trade mostly anything using this instrument. This includes anything from currency pairs to stocks, to commodities and cryptocurrencies.
Because of this, CFD trading is very popular among traders all over the world. According to the contract that a trader and a broker make, the buyer is required to pay the seller the difference between the prices of the asset before and after the deadline of the contract. Thanks to this asset, traders are able to make a profit from price movements without owning the underlying assets.
Also, a very important thing about CFDs to remember is that it does not consider the underlying value of an asset. The only thing that affects the CFD contract is the price change between the open of the contract and the deadline.
A very interesting thing about CFD trading is that it offers traders the ability to make profits during a downtrend as well as an uptrend. This is possible because while trading CFDs, you can go both long and short.
Most Traded CFDs in The World
CFDs are very frequently traded assets around the world. There are numerous Forex and CFD brokers offering traders access to hundreds of different trading assets.
This includes CFDs on stocks, commodities, indices, and so on. However, in most cases, a huge part of CFD traders are using it for crypto trading.
The most popular and biggest cryptos around the world can be traders using CFDs, and since you are not directly buying or selling cryptos, there is no need to worry about crypto wallets or anything of that sort.
All you will be doing is opening and closing contracts about the direction the price could take. This makes crypto trading using CFDs very popular. Also, cryptocurrencies are known to change in price very quickly.
This creates a lot of opportunities for CFDs traders. However, traders should remember that they might not have access to all cryptos when using CFDs. Although it is very popular to trade CFD cryptos, most of the brokers globally only offer the most popular CFDs for trading, such as Bitcoin and Ethereum for example.
How are CFDs Traded?
To trade CFDs, you are required to open a contract with a broker. As we have already said, when you are trading CFDs, you are not buying or selling any assets. All you have to do is to open a contract with a broker saying that the price of a certain underlying asset is going to increase or decrease. If your prediction is correct, the other party will be paying you money. If you make the wrong prediction, you will have to pay the difference.
As we have already said, CFDs allow traders to go long and short. This means that you are able to speculate the price movements in either direction. While you can make profits as you would with any other market (by the prices increasing), you can also make profits by decreasing the underlying asset. For example, let’s say that you believe that the shares of Amazon are going to fall in price.
To make profits, you would be selling a share of CFD to the company. If your prediction is correct, you will be exchanging the difference in price between the position opening and closing time, but you will end up earning a profit if the shares really drop. No matter which position you open, profits, as well as losses, will only be realized once the positions are closed.
CFDs Compared to Forex
CFDs and Forex trading have many similarities as well as differences. First of all, both of them involve similar trading execution processes. All you have to do is to enter or exit the positions both when the market is up, or when it is down.
Another similarity between these two is that they can be traders using the same platform. That said, there are many differences between these two as well. The main difference is that trading CFD involves different types of contracts that cover a set of different markets.
You can trade CFDs on indices, commodities, energy, and so many other assets. As for Forex, it only involves trading currency pairs. Below, we will discuss the major differences between the two markets. Below, we will discuss the major differences between CFDs and Forex trading.
Risk Factor – Forex
When discussing the risks of Forex and CFDs trading, it should be noted that both of these markets are very risky. When you are trading Forex and CFDs, you are more likely to use higher leverage than when trading other assets, for example, stocks. A very important thing that traders should know about CFDs is that these assets are mostly associated with a high level of volatility.
Let’s say that you are trading CFDs on stocks, the price of which can easily jump 10 percent a day. By using higher leverage, CFDs might be riskier than Forex. In fact, the United States’ regulator has banned trading CFDs because of the risks associated with this asset.
However, CFDs still remain to be very popular around the world because they offer traders the ability to easily trade assets that they would have a hard time accessing.
Forex is also a very risky market. There are so many things that can influence the price movements in the Forex market that it sometimes becomes very hard to take into account everything that is happening. Because of all the reasons we have listed, we believe that CFD trading is riskier than Forex trading. However, this is not the only difference between these two markets.
Research Time/Needed Knowledge – CFDs
We believe that the winner in this category is CFD trading. However, it should be noted that the time you will need to spend on research and the knowledge that you need while trading CFDs depend a lot on the underlying asset. Let’s say that you are trading CFD stocks, in this case, you will need a lot less time to research because you will only need to analyze the performance of one company.
According to the performance and future prospects of the company you are trading shares of, you can make decisions regarding your positions. The same goes for crypto CFDs trading. In this case, you will also have to worry only about the underlying asset – the crypto that you are trading. However, when you are trading Forex, there are numerous things that can influence the price movements of a currency pair.
Because of this, Forex traders are required to have more knowledge about the market as well as need more time to do extensive research and find the possible directions the market could take. Many Forex traders are using fundamental analysis as well as technical analysis to understand how the market could move in the future. This can take a lot of time especially compared to CFD trading on stocks.
Liquidity – Forex
A clear winner when comparing CFDs vs Forex liquidity is Forex. Forex trading is the largest financial market around the world and can be traded very easily any time of the day, five days a week. Liquidity in the world of finance refers to the ability of a certain asset to be bought and sold without creating a major impact on the exchange rate. Forex pairs are known for having a high level of liquidity and can be bought and sold very easily.
There always is a huge activity in the market because there always is someone who needs to exchange currencies for different reasons. Liquidity represents a very important factor for the popularity of Forex trading. Depending on the underlying asset you are trading, CFDs can be less liquid. This is true especially if we compare CFDs liquidity with the liquidity of the Forex trading market. Because Forex trading is so liquid, traders can buy large amounts of currency pairs at the same time without it having a huge impact on the price of the asset.
Margin Rates – Forex
When it comes to the available leverage in the market, both Forex and CFDs offer traders access to higher leverage than the other markets. Although there are many restrictions around the world regarding higher leverage, both Forex and CFDs offer higher leverage than the other markets.
However, in general, it should be noted that leverage offered to Forex traders tends to be higher. Forex trading is known for being a leveraged product and offers traders one of the highest leverage in the market.
While leverage can be very helpful for traders to increase their potential profits in the Forex trading market, it can also act as a double-edged sword as it also increases the risks of Forex trading and the chance of losing more money.
Although Forex offers higher leverage, CFDs are also known as leveraged products. However, depending on the underlying asset that you are trading using CFDs, the offered maximum leverage might be lower when compared to Forex trading.
Final words on CFDs
Standing for Contracts for Differences, CFDs represent one of the most popular trading assets around the world. CFDs are very well-known around the world for offering traders access to numerous trading assets. Thanks to CFDs, you can trade assets like cryptocurrencies, indices, commodities, stocks, and many others. Instead of buying the actual assets, you are simply trading by speculating on the possible price movements of the asset.
While CFDs trading is very different from Forex, these two still have many things in common. In most cases, the majority of Forex brokers tend to also offer traders access to the CFD trading market. Both of these markets offer traders higher-than-usual leverage, although Forex leverage tends to be higher. Among the most important differences and factors between these markets is the time needed for research, liquidity, risks involved, as well as margin levels. Understanding the major differences between CFDs and Forex trading can help traders make better decisions regarding which asset to use.
