Forex CFD Trading
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CFD is an agreement or contract between the trader and the CFD Broker to exchange the difference between the price of a financial asset from the opening and closing date.
Forex CFD trading is buying and selling currencies and taking advantage of their price fluctuation without owning the underlying asset.
- Leverage
- Advance Trading
- Short Selling
- Wide range of Assets
- No Physical Ownership
- Trading Restrictions
- Complex Process
- High Volatility
- Trading Cost
- Counter Party Risk
What is CFD trading?
CFD stands for contract for difference. It is a way to trade in different financial assets, including forex, cryptocurrencies, commodities, stocks, indices, etc.
CFD is an agreement or contract between the trader and the CFD Broker to exchange the difference between the price of a financial asset from the opening and closing date.
Forex CFD trading involves buying and selling currencies and taking advantage of their price fluctuation without owning the underlying asset.
When you feel that the value of a currency pair will rise, you will open a long position, and when you think it will fall, you will open a sell position.
If the price moves in your favour, the other party will pay you, and if the price moves against your prediction, you need to pay the difference to the other party.
Example of Trading CFD in Forex
Let us look at the CFD forex trading example for a better understanding. Suppose you are trading in EUR/GBP pair, and the current exchange rate is 0.87, which means 1EURO equals 0.87 Pounds.
You think that the value of EURO will rise against GBP, so you decided to open a long position worth 10,000 with a trade capital of 100 EURO using a leverage ratio of 1:100. Your prediction became true, and the rate of the pair reached 0.95.
The CFD broker will pay you 800 EURO {(0.95 – 0.87)* 10,000}. That’s how you can earn profit while trading CFD in forex without actually holding the physical ownership of currencies. However, in this case, you would have made a loss, and then you have to pay the broker 800 EURO.
How to start Forex CFD Trading
If you want to start trading CFD in forex, follow these steps for a smooth and hassle-free trading experience. It will help you understand currency trading better and make the right decisions.
Learning before earning
The first principle of trading is understanding how it functions before entering the market. Firstly, get an in-depth understanding of currency trading basics like terminologies, analysis methods, trading sessions, etc.
As you are dealing with CFDs, you must educate yourself about CFD contracts and their features for using these instruments efficiently.
Select the Currency Pairs
After getting in-depth knowledge of CFD trading, you must select the right currency pair to invest your money in.
There are a variety of currency pairs in the market that offer different trading conditions like liquidity, volatility, volume, spreads, risk, popularity, global acceptance, etc.
So select an ideal currency pair to trade in after analyzing these factors and comparing them with your needs.
Selecting a CFD Broker
For Trading CFD in Forex, you need a broker to provide you access to the currency market. Choosing a broker can be a time-consuming process; you have to look at several factors.
One of the critical aspects to look at while selecting a forex trading platform is license, registration, or regulation. Apart from these, you must check spreads, leverage, lot size, analysis tools, education resources, account types, and many other features. So, take your time and organize proper research and analysis to open a CFD trading account.
Developing an effective plan
Determine the critical criteria of your trade, like currency pair, leverage ratio, risk-to-reward ratio, trading capital, trading strategies, etc, and make your trading plan accordingly.
A well-defined trading plan is essential for effectively placing trade; as with the chances of making money, the risk of losing is also there. A trading plan is an element that makes trading different from gambling.
Start Trading Forex CFDs
The first few steps may be easy for some people; however, the real challenge arrives when you place trading. Therefore, it is necessary to practice forex CFD trading for beginners using demo accounts.
After demo account practice, place actual trade by analyzing currency trading factors like news, speeches, announcements, and geopolitical and economic conditions.
Pros of CFD Forex Trading
Well, there are many benefits of Forex CFDS. Let us quickly discuss these benefits for a better understanding:
Leverage
CFD contracts allow traders to use leverage facilities and open a large position relative to their trade capitals.
Let us look at an example: Suppose you have an account of 500 USD, and your broker is providing you with the leverage of 1:50. In this case, with the account balance of 500 USD, you can place a trade worth 2500 USD using the leverage facility.
Advance Trading
CFDs are traded over the Internet. It means you can use tools like trading software, automated systems, backtesting programs, fundamental and technical analysis resources, and many other powerful software to take your trading game to the next level.
Short Selling
Forex CFDS Traders can take advantage of rising and falling markets. In simple words, whether the prices of currency pairs are decreasing or increasing, you can make profits in both cases by opening the right positions.
Wide range of Assets
he major difference between forex trading and CFD trading is that you can trade in a wide range of assets and diversify your investment portfolio with CFD contracts.
Using these financial derivatives, you can trade in stocks, currencies, commodities, cryptocurrencies, indices, bonds, and many other financial assets.
No Physical Ownership
CFDS allows traders to take benefit of financial asset price fluctuation without owning the asset. You may have seen people buying and storing gold to make money when the price of precious metal rises in the future; well, it is a traditional way of trading.
CFDs eliminate the need to hold the physical ownership of physical assets. You can trade gold without buying, storing, or selling physical gold by opening a position using CFDs.
Cons of CFD Forex Trading
Well, no doubt, Forex CFD is an excellent way to make money in the financial market. However, with advantages, there are some disadvantages too, which you should know before trading CFD in Forex.
Trading Restrictions
Trading involves significant risk, and many traders lose large amounts of money in the market. That is the reason why there are certain restrictions traders face depending on their countries.
Forex trading is banned in some countries, while in the United States, CFD trading is not legal as it does not according to their exchange regulations.
Complex Process
There are a range of currency pairs and many strategies to trade them. The whole process takes place over the counter using different platforms.
In addition, a trader needs to master analysis and money management skills to trade effectively. Therefore, novice traders may find the process challenging.
High Volatility
Volatility is the measure of price fluctuation of the asset over the period. Traders may face higher volatility while trading in CFDs forex.
Higher volatility is the condition when the price swings are more frequent. It may result in significant profits or losses. Also, during higher volatility trading, making the right speculations becomes difficult.
Trading Cost
Traders have to pay charges to inform spreads and commissions to trade in CFDs. In addition, there are inactivity fees, withdrawal and deposit fees, and swap charges, which may affect your overall profit.
Counter Party Risk
As we have studied above, currency CFD is a contract between brokers and traders where the winning party pays a difference to the losing party.
So, it involves counterparty risk; the broker may influence or manipulate your trade. Therefore, selecting a credible and reputed broker after proper research is essential.
Conclusion
CFD trading has many benefits; the process becomes more competitive when a trader combines currencies with these financial derivatives. However, even with the best trading instrument, there are some complexities.
To counter these complexities and trade efficiently, a trader should embrace continuous learning, risk management, and analytical skills.
In the beginning, you may find the process of Forex CFD trading challenging. However, once you learn the process, you will start enjoying the process.