For most people, trading derivatives including forex can seem a little overwhelming at first. Many newcomers to trading give up in the first six months. There’s a steep learning curve, but you can manage it by making a good effort to learn. Trading CFDs can be worthwhile for people with the right mindset and a bit of training. This introduction to CFDs explains some of the essential information. For more, keep reading Exness Academy!
What are CFDs?
A CFD is a contract for difference. This is a type of financial derivative in that it derives its value from that of an underlying asset (‘the underlying’). CFDs offer traders and investors the opportunity to profit from movements in price without owning the underlying.
They can be applied to almost any underlying asset because the asset is not physically or electronically transferred to the client by the broker. This is why contracts for difference have their name: they’re contracts for the difference between the opening and closing prices of assets.
Without a doubt, the most popular type of CFD is forex, short for ‘foreign exchange’. This is the market of currencies traded against each other. However, CFDs on precious metals (mainly gold and silver), energies (mainly oil), indices and cryptocurrencies are also popular among traders.
The forex market has a daily turnover of over five trillion dollars in total leveraged trading volume; much of this is CFDs. People of all walks of life trade forex and other CFDs every working day. All you need is a way of depositing, a device that can install a trading platform and an internet connection.
Introduction to CFDs: the essentials of trading
Traders select symbols, some of which can also be pairs, on a trading platform. There are two codes in each pair: in this example, we’re looking at currencies, but the idea is the same for most other types of CFD.
The first code of a pair or symbol is the base currency in forex. The second is the counter currency (also known as the ‘quote currency’). For example, with EUR-USD, the euro is the base and the dollar the counter currency. The number for the price, let’s say $1.09, is the price you’d need to pay in dollars to buy one euro. Alternatively, it’s the amount of dollars you’d receive for selling one euro.
As noted above, though, you’re not actually exchanging deliverable money. Instead, by trading EUR-USD as a CFD, you’re agreeing with your broker to exchange the difference between the opening and closing prices of each order.
Traders basically aim to buy when they think the price will rise and sell when they think it’ll fall. If they’re correct, they close their positions and make a profit. If they’re wrong, their positions result in losses.
What’s the point of trading?
Among banks and large corporations, trading CFDs and especially forex is an important activity. These and other institutional traders attempt to reduce risks and make money by trading currencies at appropriate times and using CFDs on forex to offset or ‘hedge’ large transactions of assets. Very often it’s these large hedging positions which are entered gradually that drive trends for currencies.
For the average person in the street, though, trading is more like a way to earn some extra income. The typical retail trader takes a small amount of their total net worth and trades with it to make a higher return as a percentage. Most major banks tend to offer a maximum rate of 4-5% annually in deposit interest. By contrast, an experienced forex trader might aim for this sort of return every month.
Of course, high potential rewards come with high risks. Unprepared and reckless traders almost always lose their money. Trading is inherently riskier than depositing into a bank or investing in the traditional sense by buying shares, bonds, property, etc. This is the main reason why you should never trade with money that you can’t afford to lose.
In recent years, it’s become very convenient for retail traders to access CFD markets. The most popular trading platform, MetaTrader 4, has desktop and mobile versions. Traders can make orders and view prices and charts anywhere they have an internet connection. Requirements for minimum deposits have dropped at low as $1, so nearly anybody can start trading if they think it’s appropriate for them.
Well done and thank you for reading Exness Academy’s introduction to CFDs! If you think trading might be right for you, check out the next key article, the practical glossary of trading.
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