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CFD trading has become increasingly popular in recent years, as it allows traders to speculate on the price movement of underlying assets without actually owning those assets.
Traders can speculate in both rising and falling markets, which means traders can find ample opportunities in both bull and bear markets.
CFDs have become increasingly more popular as trading instruments, as they give traders access to trade a variety of different asset classes and the ability to use leverage. They are cost-efficient and provide traders with a high level of flexibility.
Let's continue to deep dive into what Contracts for Difference are, how traders can access them and the difference between cash and futures CFDs.
CFDs are financial instruments that allow traders to speculate on the direction of the market without owning the underlying asset. With CFDs, traders are entering into a contract with their broker, which means traders agree to exchange the difference between the opening and closing prices.
There are two prices to look for in a CFD trade: buy price and sell price. Which one traders choose will depend on whether they think the price will rise or fall.
Long position: A trader is speculating that the price of the underlying asset will increase. For example, if the trader thinks that the gold price will rise, they will buy XAU/USD. If the trader closed the position at a higher price than the opening one, they will realise a profit on the position. If the position fell however, they would have suffered a loss.
Short position: A trader goes short when they believe that the price of the underlying asset will decrease. For example, if the trader anticipates a decline in the EUR/USD, they will open a short in the currency pair. If the trader closed the position at a lower price, they will realise a profit on the position. If the position rose however, they would have suffered a loss.
Market makers: Market makers are brokers that don't hedge their client’s positions with liquidity providers, but instead take the risk themselves. This means, that a client's loss would be the broker's profit, and vice-versa.
STP (Straight-Through-Processing): STP means that there is no manual intervention from the broker when orders are executed. For the broker, it is in their best interest that the clients make money, as they will likely trade more and stay with the broker for longer.
DMA (Direct Market Access): DMA is a similar concept to STP. The key difference is that STP brokers can fill out the orders directly and hedge them with liquidity providers. On the other hand, DMA means that the orders are sent directly to the market and filled based on the pricing received by the LP.
ECN (Electronic Communications Network): An ECN broker is a type of broker that uses an ECN to automatically match buy and sell orders.
As well as the different type of CFD brokers you can trade with, there are different markets to choose from: the cash and futures market.
Cash market: The cash market (also known as spot market or physical market) is a market where a financial instrument is traded for immediate delivery. The spot price - or cash price - for a commodity is the current quote for immediate purchase, payment and delivery of that commodity. The trading of the commodity is done "on the spot".
Futures market: The futures market consists of a contract between two parties in which one party agrees to buy a certain quantity of a commodity or financial instrument at an agreed price with a pre-determined delivery date in the future.
A number of assets are more commonly priced in the futures market and oil is a great example of this. A whole raft of variables come into play here, from the grade or quality of the oil to the location of delivery, but there’s also a date when the goods are delivered, and the financial liabilities are settled between buyer and seller – that’s the point at which the contract expires.
Cash markets can operate on a regulated exchange or OTC (over the counter). OTC markets often operate 24/5 and allow more flexibility. Meanwhile, futures trading occurs on regulated exchanges.
Another key difference is the settlement date. Cash trades often get settled 2-3 days after the transaction date, while futures contracts have a pre-determined delivery date in the future that could for example be in 1, 2 or 3 months.
When trading CFDs, the main difference is the cost of holding the position overnight. Futures CFDs do not have any overnight swap charges but are subject to rollover charges when the underlying asset is due for expiry. With cash CFDs, there are no contract rollovers, but an overnight swap fee will be charged.
Short-term traders will generally prefer cash vs futures due to the lower spreads, while long-term traders may opt for futures CFDs instead, as they are less sensitive to the spread, but prefer not to pay daily swap charges.
There are a variety of financial assets that can be traded globally as a Contract for Difference. See the types of CFDs available with Axi here.
Forex: Forex trading consists of three main groups of currencies: major, minor and exotic currency pairs. The major pairs are the most widely traded pairs such as EUR/USD, GBP/USD, USD/JPY. Minor pairs consist of the cross pairs like EUR/GBP, AUD/NZD, GBP/JPY. Exotic pairs involve exotic currencies that have smaller trading volumes compared to the major and minors such as USD/ZAR, USD/RUB, USD/ILS, USD/THB.
Share CFDs: CFD contracts that are based on individual shares e.g., Amazon, Alphabet, Meta, Tesla and Apple.
Indices: CFD contracts are based on the underlying indices, including the S&P 500, Germany 40 and Nikkei 225.
Cryptocurrency: Cryptocurrencies have gained a lot of popularity in the past few years, and the number of CFD contracts available in the crypto space is rising rapidly.
Commodities: CFDs are available for frequently traded commodities such as oil, copper and natural gas, but also coffee, soybeans and cocoa.
Precious metals: Gold and Silver have both been widely traded instruments, but also Palladium and Platinum are common in the CFD trading world.
Oil: The two most commonly traded CFD contracts are USOIL (based on the WTI price) and UKOIL (based on the Brent price).
A share CFD gives traders the opportunity to speculate on the price of the underlying stock. For example, the Microsoft (MSFT) share CFD follows the price of the Microsoft stock price.
When traders invest in stocks, traders pay the full price up-front to take some ownership of shares in a company and can only profit when the price of the stock increases and they sell the shares.
Conversely, when traders trade share CFDs they are simply trading the price movements, giving them the advantage of profiting from price movements in any direction. And since share CFDs also allow traders to apply leverage, they don’t need large amounts of capital to gain the benefits of trading some of the world’s biggest stocks.
Microsoft is trading at $288.00 / $288.50. This means, traders can buy Microsoft at 288.50 and they can sell it at 288.00. Microsoft has a margin requirement of 5%, meaning they will only have to set aside 5% of the position's value as margin.
Let's assume traders buy 1 Microsoft CFD at $288.50, anticipating that it will reach $300 later in the day.
Outcome A: Microsoft shares rise
Microsoft reaches the $300 level, and traders decide to book the profit by closing their position (i.e., selling Microsoft). Traders bought Microsoft at $288.50 and sold it at $300, giving them a profit of $11.50.
Outcome B: Microsoft shares tank
Unfortunately, some bad earnings figures have led to a sell-off in Microsoft, and it hit their stop loss order at $280. The traders bought Microsoft at $288.50 and sold it at $280, which means they realised a loss of $8.50 on this position.
Cryptocurrency CFD trading through a broker is done using the broker’s existing networks and trading platforms and does not require the use of a digital wallet. Since CFDs do not require the purchase of an underlying asset, trading cryptocurrency CFDs allow for the use of leverage which helps reduce the initial capital investment while gaining exposure to the full value of a trade. When compared with the cost of purchasing an asset outright, CFD trading through a broker typically offers lower barriers to entry. And because traders are able to profit from either market direction, cryptocurrency CFD trading through a broker offers investment flexibility.
Bitcoin is trading at $40,230 / $40,260 - meaning traders can buy Bitcoin at $40,260 and sell it at $40,230.
The cryptocurrency has been recovering from a recent crash, but traders are not convinced that the downtrend has ended yet. They decide to sell 1 Lot of BTC/USD at $40,230, anticipating it to reach $38,000. To prevent excessive losses, they set their stop loss order at $41,000.
The margin requirement for the Bitcoin CFD contract is only 1%.
Outcome A: Bitcoin sell-off continues
Bitcoin continues to tumble, and eventually reaches $38,000 as traders predicted. They sold 1 contract of BTC/USD at $40,230 and bought it at $38,000 - netting a profit of $2230.
Outcome B: Bitcoin jumps
Traders underestimated Bitcoin's resilience, and the cryptocurrency gains further momentum, eventually reaching their stop loss level of $41,000. Traders sold 1 contract of BTC/USD at $40,230 and bought it back at $41,000 - leaving them with a loss of $770 on their position.
*Cryptocurrency CFDs can only be traded by Professional Clients due to FCA regulations.
Index trading is defined as the buying and selling of a specific stock market index. Investors will speculate on the price of an index rising or falling which then determines whether they will be buying or selling. Since an index represents the performance of a group of stocks, traders will not be buying any actual underlying stock, but rather buying the average performance of the group of stocks. When the price of shares for the companies within an index goes up, the value of the index increases. If the price instead falls, the value of the index will drop.
Many of the the most popular stock indexes include blue-chip stocks. Blue-chip can be defined as a well-established company with a market cap in the billions and is considered a market leader. Some popular indices include:
Trader A is holding a portfolio consisting primarily of technology stocks - including popular names such as Amazon, Alphabet and Meta. While he has a bullish outlook on the technology sector in the long run, he is concerned that we might see a significant correction in the short term. Instead of reshuffling his portfolio constantly, which would cost him a lot of time and money, he could make use of index CFDs to express his short-term view on the market and profit from it.
For example, Trader A might decide to short the USTECH index, which is based on the price of the NASDAQ 100 index. This way, he could profit from a potential decline of the NASDAQ, while keeping his long-term portfolio intact.
Gold is one of the world’s oldest and most trusted forms of currency. For traders, gold's intrinsic value makes it a popular investment and a great way to diversify a portfolio.
There are two main ways to trade gold CFDs:
Trader A is an intraday trader specialising in trading gold. His positions are running for a few minutes, and rarely longer than a few hours. He is looking for the tightest spreads possible, and swap charges are not a concern, since he never leaves positions open overnight. Trader A will therefore benefit from trading the spot product - XAU/USD - since it has lower spreads, and Trader A is not affected by the swap charges.
Trader B is a long-term trader, also specialising in gold trading. Her positions are running for multiple days, sometimes even for weeks. She is not concerned about the spread, as she trades infrequently, but swap charges are a problem, as the cost can quickly add up. Trader B would therefore benefit from trading gold futures CFDs. They have a wider spread compared to the spot product, but she will save enough money from not paying the daily swap for it to be worth it.
Oil trading is the buying and selling of different types of oil-related instruments, with the hope of generating a profit.
Often referred to as “black gold”, oil is a vital global commodity, with crude oil featuring as a basic ingredient in many different industries, including electricity, plastics, cosmetics, transportation, pharmaceuticals and petroleum. Because of its importance in global commerce, many industries monitor the price of oil very closely and also actively trade in the oil market. This gives the oil market a high level of volatility.
Oil CFDs are available as two products:
Oil cash CFDs: The oil cash price means the trading of oil ‘on the spot’. In other words, the buyer pays for the oil immediately, at the current market price.
Oil futures CFDs: The oil futures price means the buyer and seller agree in a contract to exchange a given amount of oil at an agreed-upon price at a future date. This contract is done on an exchange that acts as a third-party verifier.
USOIL is trading at 102.50 / 53. Trader A is an intraday trader and prefers the cash CFD product. He is anticipating that Oil prices will rise to 102.90 by the end of the day, and therefore buys 1 USOIL contract at 102.53.
Outcome A: Trader A correctly anticipated an intraday rally in USOIL and closes his long position at $102.90. Every $0.01 move in USOIL is worth $0.10. The difference of 37 cents, therefore, nets him a profit of $3.70.
Outcome B: Trader A was wrong, and the position is moving against him. He is monitoring the price closely, and at $102.20, he decides that it is time to close the position and prevent further losses. The price difference of 33 cents caused him a loss of $3.30.
The next day, WTI.fs (the Oil Futures CFD) is trading at 101.25 / 30. Traders can buy WTI at 101.30 and sell it at 101.25. Trader B is a swing trader and primarily trades oil. As they are holding positions for several days, the trader prefers the futures CFD product over the cash CFD product.
Trader B identifies an opportunity to profit from a further decline of the oil price. They enter a short position at 101.25 with a stop loss of 102 and a take profit order at 98.
Outcome A: Trader B was right, and concerns about an economic slowdown are pushing oil prices lower. WTI drops below $98, hitting her take profit order. Every 10 cents move in WTI.fs is worth $100. The price decline equals to $3.25, netting her a profit of $3250.
Outcome B: On-going geopolitical tensions have led to a rally in the oil price. Trader B's stop loss order at $102 has been hit, and she realised a loss of $750.
An IB traditionally refers new traders to their preferred broker for a commission. Read more about how introducing brokers operate for Axi in this guide.