KUALA LUMPUR, MALAYSIA – Media OutReach – October 20, 2023 – With countless abbreviations and many strange and unfamiliar terms, the world of finance can be confusing. One such commonly used word is “CFD”. Octa experts explain below what exactly it is and how traders can benefit from it.
Understanding CFDs
A contract for difference (CFD) is a derivative instrument that allows traders to speculate on the prices of various assets without actually owning them. CFDs are traded between traders and brokers, where the trader agrees to exchange the difference in the price of an asset between the time the contract opens and closes. In CFD trading, traders can profit from both rising and falling markets using long and short positions.
There are several types of assets that you can trade with almost any CFD broker. These include currencies, commodities (such as gold, silver, crude oil, natural gas and others), indices, stocks and cryptocurrencies. They are mainly represented in pairs, for example EURUSD, XAUUSD, BTCUSD. Indexes and stocks have ticker symbols, such as NAS100 (Nasdaq 100), AMZN (Amazon), and TSLA (Tesla).
Advantages and Disadvantages of CFD Trading
Like any form of trading, CFD trading has its own advantages and disadvantages.
Benefits of CFD Trading
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Leverage. CFDs offer high leverage, meaning traders can control a larger position with relatively little capital. A deposit of $100 with leverage of 1:500 will open market orders worth $50,000. In this way, traders amplify their potential profits (but also their potential losses).
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Wide range of asset types. CFD brokers generally offer a wide range of financial instruments in different asset classes. Traders can diversify their portfolios with currencies, commodities, indices, stocks and cryptocurrencies.
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Short sale. CFDs allow traders to profit from falling markets by selling short. Commissions and margin requirements for short positions are lower than for stock trading, while leverage is generally higher.
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No ownership. Since CFD traders do not actually own the underlying assets of the contract, they do not have to deal with issues such as their physical delivery, storage or any other type of legal paperwork and bureaucracy.
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Accessibility. CFD trading platforms are easily accessible and often offer various trading tools, educational opportunities and advanced analytics. The recommended minimum deposit is $100, which is lower than most conservative investments.
- Blanket. Traders can use CFD trading to offset some of their losses in other portfolios.
Disadvantages of CFD trading
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High risk. CFD trading involves high levels of leverage, which can result in substantial losses if the market moves against the trader. Risk management techniques help to significantly reduce the levels of risk involved in trading, but they cannot eliminate them completely.
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Complexity. CFD trading requires at least a general understanding of global financial markets and how certain factors influence asset prices. To open their first order, a trader will need a good knowledge of price charts, trading platform features and risk limitation tools (including Stop Loss and Take Profit orders). However, this information is readily available from most CFD brokers.
- Stress. Feelings such as fear, greed, and various biases can significantly influence your trading decisions, pushing you to open an order or close it at a random time dictated solely by your emotions. It is therefore crucial for traders to maintain strict trading discipline and open new orders only after a thorough analysis has been carried out.
The role of CFD brokers
Simply put, a CFD broker, such as Octa, is a service that provides intermediary services between an individual trader and the global markets. Retail traders cannot execute orders there themselves when it comes to financial markets with daily turnover in the trillions of US dollars. CFD brokers provide access to all the tools necessary for market participation, including trading instruments, platforms, indicators, analytics, educational materials and much more.
CFD Trading Fees
The three most common fees in CFD trading are spreads, swaps and commissions per transaction.
The propagation is the difference between the buy (bid) price and the sell (ask) price of a CFD. These are the main fees that the broker profits from and one of the biggest costs of CFD trading. The tighter the spread, the lower the trading cost. Brokers often offer floating spreads that can change depending on market conditions.
Trades or an overnight financing fee is charged for holding a position overnight. They depend on the interest rate differential between currencies in a pair, called the swap rate. Swaps depend on the direction of the order (short or long) and are generally charged at midnight. On Wednesday evening, traders must pay weekend swaps, which are triple the usual amount because they are accrued over two additional days: Saturday and Sunday.
Commissions are charged on each transaction. These fees are separate from the spread and generally correspond to a fixed amount per lot or per transaction. The cost of the commission varies between brokers and may depend on the type of CFD traded.
To improve trading opportunities and make trading more accessible to its clients, Octa has decided not to charge any fees, except for spreads.
It is essential to carefully read and understand the terms and conditions provided by your CFD broker of choice. Before you start trading, it is crucial to consider the total cost of trading, including spreads, commissions, swaps and any other fees. Additionally, one should be aware of how leverage can amplify both potential profits and losses, which can have a significant impact on overall trading costs. Evaluating these costs is crucial to managing risks and maximizing potential returns from CFD trading.
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