With countless abbreviations and
numerous strange and unfamiliar terms, the world of finance can be confusing.
One such commonly used word is ‘CFD’. The Octa experts explain what it is
exactly and how you can profit from it below.
What are 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 from the time the contract is opened to when it is closed. In CFD
trading, traders can profit from both rising and falling markets using long and
short positions.
There are several types of assets
you can trade with almost any CFD broker. Those include currencies, commodities
(such as gold, silver, crude oil, natural gas, and others), indices, stocks,
and cryptocurrencies. They are mostly represented in pairs, e.g. EURUSD,
XAUUSD, BTCUSD. Indices and stocks have ticker symbols, such as NAS100 (Nasdaq
100), AMZN (Amazon), and TSLA (Tesla).
Pros and cons of CFD trading
Like any form of trading, CFD
trading has its own set of advantages and disadvantages.
Advantages of CFD trading
● Leverage. CFDs
offer high leverage, meaning traders can control a larger position with a
relatively small capital. A deposit of $100 with a leverage of 1:500 will allow
opening market orders worth $50,000. In this way, traders amplify their
potential profits (but also their potential losses).
● Wide range
of asset types. CFD brokers typically provide a wide range of financial
instruments across different asset classes. Traders can diversify their
portfolios with currencies, commodities, indices, stocks, and cryptocurrencies.
● Short
selling. CFDs allow traders to profit from falling markets by short
selling. The commissions and margin requirements for short positions are lower
than in stock trading, while the leverage is generally higher.
● No
ownership. Since CFD traders don’t actually own the underlying assets in the
contract, they don’t have to deal with issues like their physical delivery,
storage, or any kind of legal paperwork and bureaucracy.
● Accessibility. CFD
trading platforms are easily accessible and often offer various trading tools,
educational opportunities, and advanced analytics. The minimum recommended
deposit is $100, which is lower than most conservative investments.
● Hedging. Traders
can use CFD trading to offset some of their losses in other portfolios.
Disadvantages
of CFD trading
● High risk. CFD
trading involves high leverage levels, which can lead to substantial losses if
the market moves against the trader. Risk management techniques help reduce the
risk levels involved in trading dramatically, and yet they cannot eliminate
them completely.
● 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 sound knowledge of price charts, trading platform
functionality, and risk-limiting tools (including Stop Loss and Take Profit
orders). However, this information is readily available with most CFD brokers.
● Stress. Such
feelings as fear, greed, and various biases can significantly influence your
trading decisions, pushing you to open an order or to close it at a random
moment dictated only by your emotions. It is, therefore, crucial for traders to
maintain strict trading discipline and open new orders only after a
considerable analysis has been performed.
Why do you
need 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 on
their own when it comes to financial markets with trillions of U.S. dollars in
daily turnover. CFD brokers give access and all the necessary tools for market
participation, including trading instruments, platforms, indicators, analytics,
educational materials, and much more.
What are the costs of CFD trading?
The three most common fees in CFD
trading are spreads, swaps, and per-trade commissions.
The
spread is the difference between a CFD’s buy (bid) and sell (ask) price.
It is the main fee the broker profits from and one of the most significant
costs in CFD trading. The tighter the spread, the lower the cost of trading.
Brokers often offer floating spreads that can change depending on market
conditions.
Swaps or
overnight funding fees are charged for holding a position overnight. They depend on the interest rate differential
between the currencies in a pair, called the swap rate. Swaps depend on the
direction of the order (short or long) and are usually charged at midnight. On
Wednesday night, traders have to pay weekend swaps, which are triple the usual
size because it is accrued over two additional days—Saturday and Sunday.
Commissions are
charged on each trade. This fee is separate from the spread and is typically a
fixed amount per lot or trade. The commission cost varies among brokers and may
depend on the type of CFD being traded.
To enhance trading opportunities and
make trading more accessible for its clients, Octa decided not to charge any
fees except for spreads.
It’s essential to carefully read and
understand the terms and conditions provided by your chosen CFD broker. Before
you start trading, consider the total cost of trading, including spreads,
commissions, swaps, and any other fees. Additionally, be aware of how leverage
can magnify both potential profits and losses, which can significantly impact
your overall trading costs. It is crucial to evaluate these costs to manage
your risk and maximise your potential returns in CFD trading.
About
Octa
Octa is an international broker that has been providing online trading
services worldwide since 2011. It offers commission-free access to financial
markets and various services already utilised by clients from 180 countries
with more than 42 million trading accounts. Free educational webinars,
articles, and analytical tools they provide help clients reach their investment
goals.
The company is involved in a comprehensive network of
charitable and humanitarian initiatives, including the improvement of
educational infrastructure and short-notice relief projects supporting local
communities.
Octa has also won more than 60 awards since its
foundation, including the ‘Best Online Broker Global 2022’ award from World
Business Outlook and the ‘Best Global Broker Asia 2022’ award from
International Business Magazine.