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What the Heck Is a CFD Anyway?

Image by Arek Socha from Pixabay 

When you’re new to the Forex markets things can get overwhelming pretty quickly. For one thing, there are all those charts you need to learn about. Plus, there is a lot of jargon that can be intimidating to new traders. For example, might have heard some of the old timers talking about a CFD, among other things.

But don’t let all the jargon confuse you. For example, CFD is an acronym for “contract for difference.” If that’s still discombobulating, read on. We’re going to explain all about CFD’s, right here and now.


A CFD Allows Traders to Speculate on Various Financial Instruments

A CFD, simply put, is contract between a Forex broker and a trader that allows the trader to speculate on the price movement of a financial instrument. For example, with a CFD you could speculate on currencies, commodities, indices, energies, and equities.

As a Forex trader, you choose a financial instrument and speculate on whether its value will increase or decrease. For example, let’s say you pick currencies. In that case, you speculate on the value of one currency against the value of another.

Then you open a trade, typically on an MT4 online trading platform. (Sometimes, traders refer to their trades as “positions.” So there. We’ve just translated another bit of Forex jargon for you.)

When you open a position with your broker, you’ve entered a contract for difference, or a CFD.

In other words, you and your broker have agreed to exchange the difference between the opening price of the contract and the closing price of the contract. Meanwhile, you never have to physically purchase or acquire the asset you’re trading.

Here’s How It Works

Let’s say you believe the price of gold will go up. So you open a buy position now while the price of gold is still fairly low. You’re hoping, of course, that you can sell your position later, when hopefully the value of the gold will be greater.

If everything goes your way, you will be able to use your CFD to profit from speculating that the price of gold would go up. However, you never would have had to buy, ship, or store, a load of gold bars.

It’s always good to remember, though, that the Forex markets are risky. If the price of gold were to drop in our fictional trade, you could lose all the money you invested, depending on the closing price of the contract. On the other hand, you can always set the price at which you wish to close your position. That is called the “stop loss” price. (There. Another bit of jargon translated.) When you set a stop loss, you minimize your risk.

With a CFD You Can Start with a Small Investment

Before the advent of online CFD trading, only financial professionals or institutions could access and profit from the global Forex markets, unless a particular individual was able somehow to physically exchange money.

Therefore, CFD’s make it possible for anyone who’s interested in the Forex markets to participate in this industry, regardless of where they are in the world.

Additionally, CFD’s are leveraged products. This means you could invest only a small amount to get started. For example, you might invest only 1% of the capital, and with that small amount you could still gain a profit from Forex market movements.

In addition, since CFD’s monetize your prediction on price movement, you can profit from “short selling.” This means that you speculate that the price of an asset will go down. Again,you don’t need to actually own that asset in a physical sense.

Therefore, regardless of how the markets are doing, there is always a way to make money and manage your risk. What’s more, you don’t have to be super wealthy already, and you don’t need to have a big pile of valuable stock shares to get started. In other words, anyone can become a Forex trader.

How Should You Go About Trading CFD’s? 

The basics of CFD trading include a laptop, an Internet connection, and an account with your Forex broker of choice.

However, you also need to have studied and practiced for several hundred hours on a demo account with your broker. Only then should you begin to take small risks in Forex trading with your own money.

Another absolute essential is that you need to have an allocated amount of money that you are willing to lose. Once you begin your Forex trading adventures, you’ll quickly learn that the Forex market is volatile. Therefore, never ever enter Forex trade with money you are not prepared to lose entirely.

Now that you know what a CFD is, are you ready to learn more? If so, set up your free MT4 demo account with Orbex, and start practicing today.