Contract for Difference trading, otherwise known as CFD trading, is a method that enables individuals to trade and invest in an asset by engaging in a contract between themselves and a broker, instead of opening a position directly on a certain market.
The trader and the broker agree between themselves to replicate market conditions and settle the difference amongst themselves when the position closes. CFD trading offers many advantages that don’t exist with direct trading, such as access to overseas markets, leveraged trading, short (SELL) positions for assets which traditionally do not offer that option and more.
How do traditional CFDs work?
The working mechanics of CFDs, usually follows the below logic, or a similar one:
- Traders choose an asset offered as a CFD by the broker. It could be a stock, an index, a currency or any other asset that the broker has in their selection.
- Traders open the position and set parameters such as whether it’s a long or short position, leverage, invested amount, and other parameters depending on the broker.
- The two engage in a contract, agreeing what the opening price for the position is, and whether or not additional fees (such as overnight fees) are involved.
- The position is opened and remains open until either the trader decides to close it or it is closed by an automatic command, such as reaching a Stop Loss or Take Profit point or the expiration of the contract.
- If the position closes in profit, the broker pays the trader. If it closes at a loss, the broker charges the trader for the difference.
Simple, right?
Although it seems so, there is sometime some confusion between CFDs and ETFs, or exchange-traded funds, that are completely different financial products.
What’s the difference between a CFD and an ETF?
While there are similarities between CFDs and ETFs, they are quite different. The similarity is that they are both derivatives.
An ETF is a fund which aggregates various financial assets into one tradable instrument, while a CFD is a contract regarding a price-change in a certain asset – meaning in both cases, you don’t actually purchase the underlying assets.
However, while ETFs are composed by financial institutions following a specific market strategy (often used to hedge risk), a CFD is offered by a broker to enable access to private users.
Similar to ETFs, CFD trading can be used to create a portfolio which follows a market strategy, giving the user absolute control over the assets they choose to hold, and enabling them to manage their own risks.
Hence, the great expectations investors and crypto-enthusiasts have towards Bakkt and other future ETFs dealings.
What about CFD trading in crypto?
Cryptocurrencies have also begun to generate a lot of interest as an alternative investment or CFDs.
A large part of this is down to headlines generated by the huge leaps in Bitcoin’s value, as the price of BTC began 2017 worth around $1,000, rocketing to more than $19,000 by December of that year. When prices move quickly, traders pay attention.
This new asset space gained further credibility when established exchanges like the CBOE and CME launched futures contracts in Bitcoin. And now more and more crypto CFD trading platforms are flooding the market.
Many people gain an exposure to cryptocurrencies by simply putting money into them – that is, buying the actual digital currency. There are downsides to this, however. Processing times for buying a cryptocurrency are slower than the instant fills that typify a Forex trade. They are unregulated and there have been scare stories of compromised Bitcoin and Ethereum wallets.
You can easily sidestep all these concerns by trading cryptocurrencies via CFDs. Using CFDs allows very fast transaction times, which is useful for such a volatile market. Admiral Markets UK Ltd is authorised and regulated by the Financial Conduct Authority (FCA), so that our Bitcoin CFD trading is regulated in the same manner as normal FX.
What next?
Want to learn more about cryptocurrency trading? Read our dedicated guides to find out more!
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.
