FX CFD stands for Foreign Exchange Contract for Difference. It is a type of derivative trading that allows you to speculate on the price movements of currency pairs without actually owning the underlying asset.
CFDs are often traded on margin, implying that you only need to put down a minor deposit (known as margin) to establish a position. It allows you to leverage your funds and potentially achieve more significant gains – or losses.
We’ve compiled a thorough tutorial covering everything from the basics to more sophisticated ideas if you’re interested in learning more about FX CFD trading.
Why trade FX CFDs?
There are many reasons traders choose to speculate in the foreign exchange market. Some of the main benefits include:
24-hour trading: The foreign currency market is open 24 hours a day, seven days a week, which means you can trade whenever convenient for you.
High liquidity: The forex market has a significant and broad liquidity pool, making it simple to enter and exit trades at the requested rate.
Low costs: Trading costs are typically meagre in the forex market, especially if you trade with a reputable online broker.
Many markets: There is a vast range of currency pairs to trade and other instruments such as metals, energies, and global stock indices.
How does FX CFD trading work?
When you trade FX CFDs with an online broker, you never own the underlying asset. Instead, you are simply speculating on its price movements.
Let’s assume you’ve just opened a long EUR/USD position at 1.3000 with a margin of 5%. This means that you will only need to put down a deposit of 5% of the total value of your trade (1.3000 x 5% = €0.065).
The broker will then lend you the remaining 95% of the value of your trade, which is effectively using leverage.
If the EUR/USD pair subsequently rise to 1.3050, your position will be in profit by 50 pips (1.3050 – 1.3000 = 0.0050). Your profit will be calculated as follows:
Profit = (1.3050 – 1.3000) x €100,000 x 5% = €250
Now, let’s say that the EUR/USD pair falls to 1.2950. Your position will be lost by 50 pips (1.3000 – 1.2950 = 0.0050). Your loss will be calculated as follows:
Loss = (1.3000 – 1.2950) x €100,000 x 5% = €250
Your profits or losses are based on each pip movement’s market value.
Most online brokers offer a handy tool called a ‘pip calculator’, which allows you to quickly and easily work out the value of each pip in the currency pair that you are trading.
What is a margin call?
When you margin trade, you take out a loan from your broker to finance the transaction. This means that your potential losses can exceed your initial deposit, so it is essential to use stop-loss orders to protect yourself from excessive losses.
Suppose the value of your account falls below a certain level (known as the ‘maintenance margin’). In that case, your broker will automatically close out your positions to prevent you from incurring further losses. It is known as a ‘margin call’.
To avoid getting a margin call, it is crucial to monitor the value of your account and make sure that you have sufficient funds to cover any potential losses.
Most online brokers offer a margin call calculator which allows you to quickly and easily calculate the required maintenance margin for your account.
What is a stop-loss order?
A stop-loss order is to sell a security at a price below its current market price to limit potential losses.
For example, let’s say that you buy EUR/USD at 1.3000 with a stop-loss order placed at 1.2950. If the EUR/USD pair falls to 1.2950, your position will be automatically closed out at that price, and you will incur a loss of 50 pips.
Stop-loss orders are an essential risk management tool and can help you limit your losses in a market downturn.
It is important to note that stop-loss orders are not guaranteed – meaning that if the market gaps lower (opens at a price below your stop-loss order), your position will be closed out at the next available price, which could be much lower than your desired stop-loss price.
What is a take-profit order?
A take-profit order is to sell a security at a price above its current market price to lock in profits.
For example, let’s say that you buy EUR/USD at 1.3000 with a take-profit order placed at 1.3050. If the EUR/USD pair rises to 1.3050, your position will be automatically closed out at that price, and you will make a profit of 50 pips.
In the end
FX CFD trading is a great way to make money if you know what you’re doing. If you’re new to FX CFDs, it’s essential to do your research and learn as much as you can before getting started.