Trading CFDs on Forex Explained

With the ability to trade on falling markets, use leverage as well as access thousands of instruments, traders and investors are taking advantage of the versatility of CFDs as part of their portfolio.

February 12, 2019 | AtoZ Markets - When it comes to forex trading, investors have several options when deciding which market they want to trade on. They can either choose to invest directly by trading in the spot market where they can buy the underlying currency in exchange for another at an agreed price.

Alternatively, they can decide to trade derivative instruments within the FX markets, such as Futures Contracts or Contracts for Difference (CFD). While Futures and CFDs have many similar functionalities, however, with CFDs, you currently do not have to pay stamp duty, especially in the UK and Ireland.

However, what exactly are CFDS?

What are CFDs?

A contract for difference or CFD is a popular form of derivative trading for European traders and investors that allows them to trade on margin. It enables them to speculate on the rising or falling of price movement of global financial instruments likes shares, indices, commodities, currencies and treasuries.

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How to trade Forex CFDs

Choose your desired instrument

CFD trading is quite similar to forex trading. When trading CFDs, you select the desired instrument you wish to trade on the platform and then enter your order.

But unlike forex trading, instead of purchasing a currency, you only buy or sell units of a certain instrument e.g. gold, crude oil, if you think the price of the underlying asset will rise or fall.

Select your trade size

With CFD trading, you can choose how many CFDs you wish to trade. 1 CFD - with equity trade - is the equivalent of 1 physical share. However, when trading forex, commodities, indices, bonds or interest rates, the value of 1 CFD varies depending on the instrument.

Add a stop loss

Before you place your trade, it is very important to put your risk management strategy into consideration and one of the technique you should apply is a stop loss. A stop loss is an order that will automatically close your position once reaches a specific level set by you. This key risk management technique helps in minimizing losses.

Monitor and close your trade

Once you have placed your trade, the profit/loss of your CFD trade will now fluctuate with each move in the market price. You can monitor market prices, see your profit/loss update in real time and also add new trades or close existing trades from your computer or by using our trading app on your smartphone or tablet.

By closing the trade, your net open profit and loss will be realized and immediately reflected in your account cash balance. However, this will be done for you if your stop loss or limit order has not been triggered.

Nevertheless, one should be aware of the risks involved in CFD trading. Just like any type of trade or investment, a wrong prediction can result in the loss of your hard earned money. Still, there are many advantages to enjoy when trading forex CFDs.

Four Advantages of Trading CFDs

Below are the key advantages of trading CFDs.

1. Leverage

One of the key benefits of trading CFDs is that you are not required to deposit the full value of a trade position, but a small percentage known as margin. This means that your money is not tied to just one transaction, but rather you can use it for other investments.

2. Explore a range of markets

With CFDs, you can trade over 15,000 markets, including forex, indices, commodities, shares, options and many more. What is more, everything is available under one login, so you do not have to switch multiple different platforms to trade different markets. CFD trading can be done via your web browser, phone or tablet.

3. Going short

CFD trading enables you to sell (short) if you think the price of an instrument will drop in value, with the sole purpose of gaining from the predicted downward price move.

If your prediction turns out to be accurate, you can then buy the instrument again at a lower price to make a profit. However, if your forecast fails to manifest and the value rises, you will lose your money. Your lost funds can exceed what you have deposited

4. Hedging

Say, for instance, you have already invested in an existing portfolio of physical shares with another broker and you believe that they may be in for a downturn over the short term, you can limit potential risk by hedging your physical shares using a short CFD.

By short selling the same shares as CFDs, you can make a profit from the short-term downward trend to offset any potential loss from your existing portfolio.

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