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CFD Forex trading

By radhika.writer, January 24th, 2010

One of the many options in FOREX trading is CFD. CFD stands for Contracts for a Difference. It is an agreement between the buyer and the seller in which the seller agrees to pay the difference between the current value of a currency and its value at the time of the realization of the contract. Thus, if the value of the currency declines, the seller would have benefited. On the other hand, if the value has increased, then it is the buyer who profits. CFD applies to stock trading as well.

With a CFD transaction profits come when (a) buying a currency when it is expected to appreciate and (b) selling the currency when is expected to decline.

Advantages of CFD trading

1. CFD requires very little capital to start (like most other FOREX transactions). Leveraging enables the trader to purchase currency using amounts 50 to 400 times the amount of money they have.

2. Profits can be realized irrespective of whether the market is doing well or badly. This is because the trader is concerned with the difference between the base price (price when contract was signed) and the price when the contract was realized. He does not really need the maximum or minimum values of the currency.

3. There are also quite low commission rates with CFDs.

4. The execution of the deal is immediate.

Disadvantages of CFD trading

1. Abuse of leveraging can lead to insolvency in case of projections turning sour. It is in fact recommended to use leveraging sparingly or to have the necessary back-up funds to cater for any fall in revenues if the market does not go the trader's way. Overtrading can lead to many losses, even causing the trader to fail. Experts concur in saying that a trader who cannot trade unleveraged should probably not look at CFDs.

2. Certain brokers may work against you by influencing you to sell your currency at a loss.

Tips for successful CFD trading

1. Adequate Risk Management-providing for stop loss orders is essential. These allow the trader to exit the market very rapidly if the market moves too fast. With CFDs, the losses can easily exceed the capital. Stop orders are therefore crucial in managing the risks.

2. Set up a profitable strategy-this can be done by testing the viability of the strategy against market events of the past. However, successful strategies based on historical events are not guaranteed to succeed in real life. Some platforms offer practice accounts that can be very useful to evaluate your strategies.

3. Recognise market conditions-if your strategy is not adapted to current market situations, take steps to correct it immediately. This will ensure long-term success.