What are CFDs and How to Trade them?

The rise of technology had a huge impact on the financial sector as it enabled more and more people to invest in assets. In particular, the derivatives market saw the greatest rise, allowed access to the financial world even for those with limited capital.

Contracts for Difference (CFDs) are some of the most popular derivatives because they enable people to speculate on rising and falling prices of instruments like shares, currencies, commodities, indices, etc.

Benefits of CFDs

Leverage is one of the biggest advantages of CFD trading, meaning that you only need to deposit a small percentage of the full value of the trade in order to open a trading position. People need to understand that while margin can amplify returns, losses are as well since they are based on the full value of the CFD position.

In some countries, trading CFDs is also tax efficient which is why some people think it is much better to trade them as opposed to trading the underlying assets.

Introduction to CFD trading

One of the mantras governing financial markets is “ history repeats itself”. Although that that 100% true, what you can be absolutely sure is that you’ll constantly see recurring patterns. The price will tend to fluctuate in a particular way over time, which means you are able to design a set of rules, a.k.a. a trading strategy, by which you will abide each time you want to buy or sell CFDs on a particular instrument.

When it comes to creating a trading strategy, this usually is being done based on three important pillars:

  • Technical analysis;
  • Fundamental analysis;
  • Market sentiment analysis;

Technical analysis principles suggest that one could anticipate future price moves based on past performance. That happens because the price is a reflection of the underlying order flow that influences the future trend. There are many ways to use technical analysis, including price indicators, pivot points, support/resistance levels, candlestick patterns, etc. all with positive and negative aspects.

Fundamental analysis, on the other hand, tries to anticipate future price moves based on the performance of several economic indicators. GDP, inflation, unemployment, company earnings, supply/demand for commodities, and many others, help traders better understand the market from a “fundamental” point of view.

Market sentiment analysis has more to do with the psychology of the market participants. As a trader, you’ll need to understand how other market players (especially big financial companies) will make trading decisions and what events might influence their decision-making process.

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