For many people, the only foreign exchange transactions they will do are performed physically at a currency exchange. However, most of the daily currency transactions worldwide are done by business people who need to protect themselves against fluctuations in exchange rates, and speculators who try to profit from them.
Many speculators trade using an online brokerage account, and often they are not actually exchanging currencies. Instead, they trade products called Contracts For Difference, or CFDs.
Once for financial professionals, CFDs are now widely available to the public. Here is what you need to know about them.
How do CFDs work?
When you are trading CFDs on forex, you are not buying another currency like you would at a currency exchange. What you are actually doing is agreeing to a contract with the CFD broker. This stipulates that one of you will pay the other the difference between the current value of the currency pair in question and its value at a later date.
For example, instead of buying $500 worth of Euros, you could buy a $500 CFD. If the price of a Euro is up 10% when you close the trade, the broker would pay you $50, because that’s 10% of $500. If it went down 10%, they will take $50 from you.
Because a CFD is just a contract and does not involve buying any actual currency, you can use leverage. When you use leverage, you essentially agree with the broker to multiply your profit or loss by a certain amount. The example above traded with 10x leverage would mean that, even though the price of the currency only moved up 10%, the winner would pay the loser $500. This basically means that you can trade using more money than you actually have.
How to trade CFDs on forex?
First, you have to find a CFD broker. There are lots of them online, but as you will need to deposit money with them you should check out where they are registered and whether they are regulated. Other things to look for is whether they offer the currency pairs that you want to trade, and how easy you find it to navigate their platform.
Different brokerages will also have different fees. When trading CFDs, it is not unusual for a small fee to be charged each night before you end your trade. Like a traditional currency exchange, CFD breakers also have a different buy and sell price for each asset. You will want to look for a broker where the difference between these, known as the spread, is very small.
Once you are signed up to a good platform, placing a trade should be intuitive. You choose a currency pair, select whether you want to buy or sell it, then enter the amount you would like to trade and how much leverage you want to use.
Can I lose money? Yes, and with leverage it can be lost very fast. One way to prevent this is to place a stop-loss order. This will end your trade if you lose a certain amount of money. Many brokers will make you place one as a precaution, but be warned that they may not work if the price is moving too fast.
