CFD trading is extremely versatile and applies to a number of different financial instruments. This can include: bonds, shares, commodities, metals, forex, energy, indices, stocks, currencies and cryptocurrencies.
But, if you’re new to the world of foreign exchange trading, then you may be wondering what a CFD is. In this article, we’ll explain what it means to trade forex using CFDs.
What is CFD trading?
CFD stands for ‘contract for difference’. This is a contract that is made between an investor and an investment broker. The contract is an agreement between the two parties stating that they will exchange the difference between the opening and closing prices of a trade, at the end of the contract.
So, now you know what a CFD is, read on to learn more about trading forex using CFDs.
How does CFD trading work?
One of the defining conditions of a CFD trade is that the investor does not own the underlying asset. A contract for difference has both a buy and sell price, which differ from their market value, being either higher or lower in price. The difference between the buy and sell price is called a spread and for CFD analysis this involves attempting to predict the fluctuation of these prices.
Strategies for trading forex using CFDs are very similar to that of standard forex trading. One of the benefits of CFD trading is the trader’s ability to trade on margin. This means that if you expect that prices will dip, you should sell or go long, and you should buy if you predict that prices will increase. Other benefits of CFD trading include their tax efficiency, as stamp duty does not apply.
Trading Forex using CFDs
As opposed to trading currencies directly, trading using CFDs will mean that traders don’t actually own any of the currencies.
Instead, investors will own the contracts which are relevant to the indexed price of the currencies that are being traded. This is advantageous as trading on currencies directly will cause traders to encounter differing exchange rates and legislative structures, whereas this can be avoided when partaking in CFD trading.
Trading forex using CFDs is highly popular amongst those who have pre-existing CFD accounts. This is because it affords them the ability to trade on foreign accounts easily, using the same account.
What is CFD trading using leverage?
Leverage utilises a deposit, called a margin, which will allow you to gain additional exposure to an underlying asset. This means that you will put down a percentage of the total value of your trade, whilst the rest is loaned to you by your provider.
With a leveraged CFD trade, you are able to spread your investments further, as you only have to provide a reduced portion of the cost. This is an attractive feature of CFD trading as it allows investors to control a larger position of investments.
What will it cost to trade forex using CFDs?
CFD trading requires you to pay the spread. As previously mentioned, the spread is the difference between the buy and sell price. The narrower the spread between the buy and sell price, the less that price will have to move in your favour in order for you to make a profit.
A CFD holding cost is the amount that you may be subject to pay at the end of a trading day for any positions that are currently open in your account. Depending on whether the direction of your position is favourable or not, this holding cost could be either positive or negative.
CFD trading is a popular strategy for forex investors for multiple reasons. It is convenient for those who already have a CFD account, allowing them easy access to participate in trade on the foreign exchange market. It also means that investors can avoid legislative frameworks and differing exchange rates.
In addition to offering leverage, CFD trading accommodates hedging, meaning that you could open a CFD to minimise the risk of potential losses when you own the asset and anticipate that share prices will drop.