Many traders in Nigeria explore other opportunities beyond Forex. Contracts for Difference, or CFDs, are more accessible than stocks or futures. These are virtual derivatives that are bought and sold online. Thanks to high leverage, traders can achieve spectacular returns. However, there are a few caveats to know about CFD trading.
Contracts for Difference are a special type of derivative. Their movements mirror those of the underlying asset. CFD holders do not own the latter. Instead, they speculate on price changes alone. This makes CFDs attractive and accessible to many.
Unlike futures, they are not linked to physical delivery and do not have an expiry date. CFDs are agreements between the broker and the client. The ‘difference’ here is the difference in price between the entry and exit points. Thus, by trading at the right moment, you can make a profit. The instrument is highly leveraged, which means you can open positions worth more than your deposit.
CFDs may be linked to different types of assets. In Nigeria, the Forextime broker provides access to a wide range of options:
- CFDs on stocks,
- CFDs on commodities,
- CFDs on cryptocurrencies, and
- CFDs on market indices.
Traders predict where the price will go and buy or sell accordingly. If you are familiar with Forex or stocks, the logic is similar.
When a rise is expected, a trader may purchase more CFDs on the asset. When a fall is most likely, they will short-sell what they own and buy back more CFDs for less money. Here is how profit is calculated: point movement x the number of units traded.
Both long and short positions are acceptable. Consequently, any trend can be lucrative. Learn more on what is CFD trading with a global brokerage in Nigeria.
Long positions are initiated when you buy, and short – when you sell. Long positions are called this way because traders hold on to their instruments waiting for the price to spike. If their prediction is correct, they make a profit. If the market moves in the opposite direction, they lose.
However, CFDs generally move quickly, so you wouldn’t wait long. Traders need to monitor factors affecting the value of their underlying assets. For instance, CFDs on stocks move in line with the equities. The only difference is that no ownership is needed. Therefore, an asset you know well can be traded directly and indirectly through CFDs.
When you trade on margin, your positions cost more than your deposit. The term ‘margin’ denotes the required size of investment. The leverage, on the other hand, denotes the funds lent by the broker. It is usually expressed as a proportion or percentage. For instance, 1:100 means you may open a position worth $100,000 having just $1,000 in your account. This ratio depends on liquidity and volatility of the asset.
The system differs from the conventional ways of trading. For instance, if you were to purchase stocks directly, it would cost you the actual value of the equity. This means that 1,000 shares worth $15 each would require an investment of $15,000.
Leverage on CFDs allows you to make higher profit with what you have. However, it must be used with caution. As potential returns grow, so do the risks. A bad decision can wipe out your account in an instant.
CFDs have a few important benefits. These are:
- High leverage (see above);
- Increased liquidity (CFDs are easier to trade than stocks; liquidity in the underlying market is complemented by liquidity from the provider);
- Long and short positions (an opportunity to profit from any trends);
- All-in-one software (trading terminals like MetaTrader 5 allow creation and management of diverse portfolios with currencies, CFDs, stocks, and more);
- A wide range of underlying assets.
Of course, CFDs have their own weaknesses. No trading instrument is ideal.
- CFD traders may incur significant losses if their decisions are failed.
- Some brokers may close your account if the balance falls below a certain threshold.
- Positions that are open overnight entail overnight fees.
- Finally, as the market is volatile, a sudden change can work against you.
The derivatives allow you to profit from a wide range of underlying assets. This is indirect, as physical ownership is not involved. CFDs may be bought and sold using trading terminals like MetaTrader 5, which are also used for Forex trades. As an addition to trading portfolios, CFDs help to hedge risks. At the same time, they are volatile and leveraged, so poor decisions can be extremely costly.