The current capital market is quite volatile. This volatility has not only had an impact on asset classes but is also controlling the demand of financial products offering leverage. Contract for differences is a financial tool used to track a variety of assets. These underlying assets include cryptocurrencies, indices, commodities, individual equity shares, and forex.
CFD is different from underlying tools in that you aren’t required to post the total capital amount to purchase underlying instruments. As an alternative, you need enough capital to cover the price change of the place you want to enter and exit the trade.
Can CFDs offer leverage?
Each CFD has a rooted leverage feature that differs from one broker to another and from one asset to the other. Leverage enhances trading returns because it enables you to add to the capital you’re controlling using borrowed capital.
For example, some brokers allow buying of $4000 EUR/USD with a $10 collateral. To be able to use leverage, you first open a margin account. Brokers have different conditions for opening these margin accounts. In general, you’ll be asked about your trading history and investment knowledge.
You must understand how trading returns are impacted by leverage. Assume you purchase $4,000 of EUR/USD and using a 400-1 leverage. It’ll take a mere 0.25% move ($4,000 * 0.0025 = $10) to either wipe your capital out or double it. This makes leverage a double-edged sword that can cut both ends.
CFD trading can sometimes be a risky affair, more so when leverage is being used. It would be best if you created plans before making a trade. To evade getting ruined, you should cap the capital you place on trades. For instance, you are limited to 5% to 10% of your portfolio. Thus, if you have a $5,000 portfolio, the most you can post on a trade is $500. This strategy is most beneficial to those starting slowly.
Another useful concept is cutting the losses and allow profits to run. Should the market move contrary to you hitting the stop loss you have, it’s time to exit and live to fight another day. On the flip side, if the market’s moves favor you, increase your stop-loss, then let the gains compound.
Tips for Traders
Here are some top tips for traders who would like to learn and use CFD:
- Begin with demo accounts: These simulation accounts will give you a chance to get familiarized with the effects of market moves. To make it realistic, use the same amount you would when trading in real life.
- Conduct research: Learn of the many different financial instruments available to you. Understand CFD trading terminologies and know what stop orders and leverages are in risk management.
- Recognize the platforms: Platforms like MT5 and MT4 are leading in the industry. MT5 is a new platform from MetaQuotes which provides you with access to assets and various institutional tools. MT4 is your gateway to some CFDs, Forex markets, and futures trading.
- Leveraging wisely: Ensure that your portfolio is cautiously leveraged to prevent increased losses.
- Don’t put it all in one place: Purpose to have a diversified portfolio. That way, you will be ready for different market conditions. Start with asset classes investment with negative or low correlations. That way, if trade falls, the other will probably counteract it.
- Choose a reliable broker: Get a regulated broker. This means that the broker is registered in whichever country s/he is operating in. It is also essential that your broker is within reach physically. That way, you can reach them whenever you want assistance.
With CFDs, you won’t have to purchase underlying instruments to be able to trade capital markets. CFDs are used to keep track of underlying instruments. They also provide leverage, thereby increasing your returns. This includes cryptocurrencies, forex, indices, commodities, and equity shares. To trade, get a registered broker, and open a margin account with them.
While leverage has the potential of considerably increasing your trading returns, it could also cause robust losses. That is why you need a risk management plan that is well thought out and can be employed in all trades. Create one before you risk your hard-earned trading capital.