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Consider CFD (Contracts for Differences) trading as sailing the high seas.
What makes your journey an enjoyable one depends on the quality of your ship and how good your navigational skills are.
Just as the right ship is essential for a captain, having the ability to select the right CFD asset to trade is essential for a trader or investor.
What are CFDs or ‘Contracts for Differences’?
A CFD is a leveraged financial derivative product that traders use to buy (enter a long position) and sell (enter a short position) based on the underlying price movement of an asset without owning it. A CFD is an agreement to exchange the price difference in the value of an asset from the time the contract is opened to when it is closed. It is essentially speculation on the rise or fall of the price of, say, a currency pair, such as the EUR/USD or GBP/USD, or an equity index, like the FTSE 100 or even major Digital Currencies, such as BTC/USD. CFDs are also commonly used as a hedging tool.
What sets CFDs apart from traditional trading is their increased leverage and flexibility. It allows traders to open a larger position without coughing up the full cost upfront, better known as ‘margin’. While trading on margin (employing leverage) can lead to increased gains, it is crucial to understand that it can equally lead to increased losses. This is why you commonly hear the term ‘double-edged sword’ to reflect leveraged trading.
The CFDs a trader or investor selects to trade will be dependent on several factors. The selection process will be detailed in your overall trading plan, encompassing trading strategies, trading goals, risk-management strategies, etc.
How you approach risk can help determine which group of CFD products are selected.
If you are the safety-first type of trader, you might want to select more stable assets so that it helps your capital avoid extreme price swings, also known as ‘volatility’. On the other hand, if you have a higher risk tolerance (risk appetite), you’d likely be more comfortable trading underlying assets with higher price fluctuations that may generate more significant returns.
Knowing which side you lean on helps you navigate the choices available to select assets that align with your comfort level, financial goals, and overall trading strategy.
Having a deep understanding of the market you trade is essential. This also forms part of your risk-management approach, as a lack of knowledge can prove a costly mistake (an unnecessary one).
How to research your chosen markets often includes the following:
How one selects their CFDs to trade could be down to their diversification strategies. Traders using CFDs as a diversification tool will seek uncorrelated asset classes to help mitigate downside fluctuations.
Non-systematic (or unsystematic risk or diversifiable risk) is confined to a specific asset class or security and is essentially a function of the behaviour of a particular asset. Portfolio diversification can help mitigate non-systematic risks, reducing exposure and reliance on one specific asset class.
Examples of diversifiable risk focus more on the microeconomic side of the table, and systematic risk focusses more on a macro-based picture. Examples of unsystematic risk can include regulation changes that affect one industry or the entry of a new competitor, which could cause the supply curve to shift right, meaning more quantity is produced at the same prices. Other examples are management risks—poorly managed companies. An employee strike is another one.
Most reputable Forex brokerages offer user-friendly demo accounts with excellent trading tools where you can practice trading in a risk-free environment. Opening a demo account with FP Markets takes only a few minutes; this gives you the time to familiarise yourself with different CFD assets and the platform you are trading on. It also allows you to refine your trading strategies before committing your hard-earned capital.
There's significant value in leveraging the knowledge of experienced individuals in the field. Webinars, workshops, and seminars by seasoned traders can provide fresh perspectives and invaluable insights. While some of these may charge expensive fees, you can always check out the resources provided by FP Markets for free to navigate your journey as a trader.
Choosing the right CFD asset or CFD broker might seem daunting, but with the right guidance and a reliable trading platform, the task becomes significantly more straightforward. FP Markets, a leading Forex and CFDs broker, offers an extensive range of CFD assets, along with intuitive trading platforms, such as MetaTrader 4 (MT4), MetaTrader 5 (MT5) and cTrader, as well as robust educational resources delivered by industry experts.
Remember, every expert was once a beginner. With dedication, continuous learning, and the right tools, you'll be on your way to making informed decisions in the world of CFD trading.
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