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A contract-for-difference (CFD) can be a convenient way to speculate on the price of an asset without ever having to hold or manage the asset itself. Cryptocurrency CFDs let traders go long or short on a range of cryptocurrencies, as well as use leverage.
So, what exactly are cryptocurrency CFDs, how do they work and what are the risks involved in trading them? Keep reading to find out.
Cryptocurrency CFDs are an increasingly popular product on a variety of online CFD trading platforms. The details of some of these platforms and their cryptocurrency trading options are included in the table below.
CFD's belongs to a group of investment vehicles known as derivatives. Instead of owning the underlying asset (ie, the actual cryptocurrency), derivatives and CFDs are used to speculate on the price of the underlying asset. So a Bitcoin CFD tracks the price of Bitcoin, allowing you to trade it without having to own or manage any Bitcoin itself. For those familiar with financial markets but not cryptocurrency, this can be a convenient way to trade.
When you open a CFD trade, you bet on whether you expect the value of that underlying asset to increase or decrease. You never actually own the asset, but instead make a profit or loss based on whether the asset rises or falls in value. As such crypto CFDs are usually settled in fiat currencies (like US dollars) rather than the associated cryptocurrency.
For every point the price moves in your nominated direction, you'll be paid multiples of the number of units you have bought or sold. However, if the price moves in the opposite direction to the one you predicted, you'll take a loss.
Cryptocurrency CFDs allow you to speculate on the value of a cryptocurrency pair, such as the following:
If you think the value of a cryptocurrency will rise, you can “go long”; if you expect it to decrease, you can “go short”. This offers the potential for you to make a profit in both rising and falling markets.
One of the key concepts you need to understand before trading cryptocurrency CFDs is leverage, which is both a key benefit and disadvantage of this type of derivative. To open a CFD trade, you only need to deposit a small percentage of the trade’s total value. This could be 20%, 5% or even less of the total transaction and is known as the margin requirement. So if you’re opening a trade worth $10,000, for example, you may only need to pay a deposit of $500. However, you can still receive 100% of gains if the price moves the way you predict.
On one hand, trading on margin allows you to magnify your returns, providing the potential for a much bigger return from a relatively minimal initial amount. On the other hand, it also means your losses are magnified as they are calculated based on the full value of the position. This means you could end up losing much more than your initial deposit. This is a key risk you must be aware of before getting into crypto CFDs.
If you're considering trading cryptocurrency CFDs, make sure you understand all the important terms and technical jargon first. Key terms you need to know include the following:
Ask price. This is the price at which you can buy a CFD.
Bid price. This is the price at which you can sell a CFD.
Leverage. Leverage is a trading tool that allows you to buy and sell CFDs with more capital than you actually have. As CFDs are leveraged, you only need to deposit a certain percentage of the full value of the trade to open a position. For example, if you open a position on a cryptocurrency with $1,000 and select leverage of 5:1, your trade is worth five times your initial outlay – so $5,000 instead of the $1,000 you committed upfront. Using leverage allows you to enjoy greater profits if the price moves in your favour, but it also means you'll suffer greater losses if the price moves against you.
Margin. This is the amount of money you'll be required to deposit to open a CFD position. For example, if the margin requirement is 20% and you're placing a trade worth $1,000, you'd need to deposit $200.
Stop loss. A stop loss order is a trading tool that allows you to set a predetermined price level at which your CFD position will be closed. This allows you to minimise your losses if the market moves against you.
Take profit. A take profit order functions in much the same way as a stop loss order, but with the key difference that you set the price level at which your position will be closed so that you can secure any profits before the market moves against you.
When most people buy and sell cryptocurrencies, they do so through a cryptocurrency exchange. This involves using fiat or digital currency to buy the crypto coins of your choice, then holding those coins for a period of time in the hope that they'll increase in price and you'll be able to sell them for a profit at a later date. It's a simple and straightforward way to potentially benefit from cryptocurrency price rises, and trades can be placed on centralised or decentralised exchange platforms.
CFDs offer a different and more complicated way to trade cryptocurrency. Although they're a relatively new addition to the world of crypto, CFDs have been around for a long time in other financial markets such as shares, forex and commodities. The key difference that sets them apart from buying coins or tokens on an exchange is that when you trade CFDs, you never actually own any cryptocurrency – rather, you forecast whether the value of a particular digital currency will go up or down. If the price of that cryptocurrency moves in the direction you predict, you will make a profit, but if the price moves against you, you will have a loss.
Though CFDs are more involved and intimidating than the straight-up buying and selling of cryptos, they do allow you to avoid the security risks associated with trading on an exchange. They also offer the chance to profit in rising and falling markets and the potential for higher rewards – but with these benefits comes an increased level of risk.
The following are some of the potential benefits to trading cryptocurrency CFDs:
However, you should also make sure you’re fully aware of all the following risks associated with cryptocurrency CFDs:
Whether you want to buy and hold cryptocurrency, trade cryptocurrency CFDs or even pursue both options depends on your personal preferences and trading habits.
Buying cryptocurrency, holding it for a certain amount of time and then selling it for a profit (hopefully) is generally regarded as a more popular option for people looking towards the long-term.
Unless the crypto you purchase hits a value of $0, there’s minimal risk of losing all your money with this approach. However, you will need to contend with higher spreads than are offered on CFDs, not to mention the hassle and risks associated with buying crypto on an exchange (such as security threats and the need to open a secure wallet to store your coins).
On the flip side, cryptocurrency CFDs are commonly seen as being worth considering for advanced traders who are keen to adopt short-term positions. Their lower spreads make it possible to capitalise on smaller price movements, while there’s also the potential to profit regardless of whether the market is going up or down. Of course, there’s also the fact that margin trading means any gains are magnified.
However, margin trading makes CFDs very risky and, when they’re combined with highly volatile cryptocurrencies, there’s a very real danger of suffering substantial losses. In November 2017, the UK’s Financial Conduct Authority even went as far as to issue a warning about what it described as “extremely high-risk, speculative” cryptocurrency CFDs, which should be enough to make any trader tread with caution.
The most important thing to remember is that, in the right circumstances, both options can potentially provide positive results, just like you could also suffer sizable losses if things go wrong. Whichever option you choose is entirely up to you and your preferred trading style.
At the time of writing, the author holds XLM and IOTA.
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