Contract for Difference (CFD) trading is a method of investing in financial markets without owning the underlying asset. Instead, it involves speculating on the price movement of assets like stocks, commodities, currencies, or indices. When you trade CFDs, you enter into a contract with a broker, agreeing to exchange the difference in the price of an asset from the time the contract is opened to when it’s closed.
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Fair CFD trading business
Here’s how it generally works:
- Opening a Position: You choose an asset and decide whether you believe its price will rise (buy/long) or fall (sell/short). You don’t own the asset itself; you’re simply speculating on its price movement.
- Leverage: CFDs often allow trading on margin, which means you can control a larger position size with a smaller amount of capital. Leverage can amplify both profits and losses.
- Profit and Loss: If the market moves in the direction you predicted, you make a profit proportional to the price change. Conversely, if the market moves against your prediction, you incur a loss.
- No Ownership: Unlike traditional investing where you own the asset, CFDs only involve the price movement. You don’t have ownership rights or dividends associated with the underlying asset.
- Flexible Trading: CFDs enable trading in both rising and falling markets, providing opportunities in various market conditions.
- Costs and Fees: Costs include spreads (the difference between buying and selling prices), overnight financing fees for holding positions overnight, and sometimes commissions.
- Risk Management: Stop-loss orders and limit orders can help manage risks by automatically closing positions at predetermined price levels.
CFD trading offers flexibility and the potential for higher returns due to leverage, but it also carries significant risks. The leveraged nature of CFDs means that profits and losses can be substantial, and it’s crucial to have a good understanding of the market and risk management strategies before engaging in CFD trading.
Let’s see some example with numbers to sense CFD trading better. Let BItcoin be a CDF asset.
Suppose you believe that the price of Bitcoin (BTC) will increase in the near future. Instead of buying actual Bitcoin on a cryptocurrency exchange, you decide to trade Bitcoin CFDs through a broker.
- Opening the Position: You open a CFD position for Bitcoin at the current price of $50,000 per BTC. You decide to buy (go long) one Bitcoin CFD.
- Leverage: Your broker offers a leverage of 10:1. This means you only need to deposit 10% of the total trade value as margin. So, for one Bitcoin CFD at $50,000, your initial margin requirement is $5,000 (10% of $50,000).
- Price Movement: If the price of Bitcoin rises to $55,000 per BTC, that’s a $5,000 increase from your entry price. Each CFD contract typically represents the change in price, so you’ve made a $5,000 profit on the CFD.
- Profit Calculation: With a $5,000 profit and a leverage of 10:1, your actual profit would be $50,000 ($5,000 x 10), which is ten times your initial margin.
- Conversely: If the price drops to $45,000 per BTC, you’d incur a $5,000 loss on the CFD. Again, the leverage amplifies both gains and losses.
- Closing the Position: You decide to close your position when the price hits $55,000. You sell the Bitcoin CFD back to the broker and lock in your profit.
In real systems, if you failed to predict correctly the price (bitcoin price dropped to 45,000$), broker will close your position and will take your deposit, so you will lose 5000$.
Seems really attracting, does not it? If you predict correctly, you win 50,000$. If you fail on your prediction, you lose 5,000$. The question you may ask is “How broker makes money from this? If broker should pay 50,000$ on my win and takes only 5,000$ on my failure, in long term, broker will be in money deficit finally”.
The answer is that brokers in CFD trading make profits through various means, including spreads, commissions, and overnight financing charges rather than directly from the losses or gains of individual traders.
Here’s how brokers typically make profits:
- Spreads: Brokers often charge a spread, which is the difference between the buying (ask) and selling (bid) prices of an asset. This difference represents their profit margin on each trade executed by traders.
- Commissions: Some brokers may charge commissions on trades, especially for certain types of CFDs or for offering additional services.
- Overnight Financing: If positions are held overnight (i.e., not closed by the end of the trading day), brokers may charge or pay a fee based on the interest rate differentials between the currencies involved in the trade.
- Leverage and Risk Management: Brokers impose margin requirements and risk management tools to ensure traders can cover their potential losses. They might close out positions if they sense a trader’s account is at risk of falling below the required margin.
While individual traders’ gains or losses are independent of each other, brokers make profits from the collective trades executed by their clients, taking into account the spreads, commissions, and other fees they charge.
Note that while traders’ wins and losses are a zero-sum game (one trader’s gain is another’s loss), brokers’ profits come from the fees and spreads they charge, and they are not directly impacted by individual traders’ wins or losses.
Ok, so broker is in losses on the CFD trading but covers them with other activities. But then it seems you are in win on long term. Say, you play 100 times. Say, you predicted 50% correctly and 50% incorrectly, just guided by tossing a fair coin. You lost 5000$ * 50=25,000. But you also won 50,000 * 50 = 250,000$.
Unfair CFD trading business
Riding on the reputation of fair CFD businesses, numerous parasitic platforms have proliferated, masquerading as trustworthy and legitimate sites. The mechanism is straightforward: users register for the system, access a dashboard, deposit funds, and commence trading. However, if you achieve success, retrieving your winnings becomes an elusive endeavor, plagued by a myriad of reasons. Beware and exercise caution.
Lead and FTD
Having understood the mechanisms, let’s delve into defining two pivotal terms associated with unfair CFD trading platforms: lead and FTD.
A LEAD signifies the act of registering on the platform. Typically, users provide their name, email, phone number, and country data via the registration form.
On the other hand, FTD stands for First-Time Deposit, representing the most crucial action expected by such platforms from their clients. This initial deposit indicates the client’s interest in trading. Moreover, it implies the potential for subsequent deposits: STD (second-time deposit), TTD (third-time deposit), and so forth. However, it’s important to note that funds deposited may unlikely be returned to the client.
Competition
There exists fierce competition among fair platforms, among unfair ones, and even between fair and unfair platforms. In essence, it’s a scenario where every entity competes with one another, irrespective of whether the competitor is fair or unfair.
So, how do these broker platforms acquire their clients? Typically, they seek assistance from affiliate sites that actively promote registration on specific platforms. These affiliate sites host the registration forms and drive users to the broker system. In return, the broker system compensates the affiliate with generous rewards for every new client they bring in.
Furthermore, if you possess lead or FTD data (which includes the name, address, email, and phone number of a user who registered on one of these systems), you might opt to sell this information to another system. The purpose behind this could be to ‘reutilize’ the client for themselves. For instance, they may entice the user with the promise of greater profits from subsequent FTDs.
How to know if platform is fair or unfair?
It’s an incredibly challenging task. Assessing a platform often entails registering and making a deposit, which typically involves a considerable sum, ranging from $200 to $1000 USD.
Testing each platform, given their abundance, can be impractical, risking an average of $600 on every platform. The most reliable method to ascertain a platform’s fairness is to glean insights from individuals you trust — those who have personally tested a specific system and shared their experiences.
Wishing you the best of luck, and may fortune favor you throughout your endeavors!