Contract for Difference (CFD) trading is a highly-popular financial instrument that is used to trade on assets like foreign currency (FOREX), commodities, and indices that are listed on the global financial markets.
However, at the outset of this article two things must be noted:
It is best to get the “bad news” out of the way first. Moreover, it does not mean that you should eschew CFD trading. The good news is that knowledge, understanding, and skill, counterbalance and mitigate the risk of trading on CFDs.
Before we look at the essential CFD tools, let’s have a quick look at what a Contract for Difference is, and how, as a financial marketing trading instrument, it can be leveraged to derive a trading profit and grow your investment portfolio.
According to Wikipedia.com, a Contract for Difference is a “contract between two parties, typically described as “buyer” and “seller”, stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time (if the difference is negative, then the buyer pays instead to the seller).”
The salient point and purpose of a CFD are that it is a trading instrument that allows investors to trade on the price movements of an underlying asset without having to purchase large volumes of the stated asset.
Basically, all a trader has to do is to determine which way an asset’s price will move (up or down) within a predetermined time frame. And then enter into a contract with the broker by placing a trade.
It is vital to remember that this is an oversimplified explanation of how CFD trading operates. In practice, CFD trading is slightly more complicated.
As mentioned above, the only way to trading on CFDs profitably is to ensure that you have a good understanding of the analysis that is involved when determining what asset to trade on and what parameters to use when placing the trade.
To this end, there are two broad categories of analysis that need to be looked at while determining what asset to trade on as well as what investment strategy to use.
However, the scope of this discussion is only to consider how the study of the fundamentals that can affect an underlying asset’s price.
Geopolitical and socio-economic events
Succinctly stated, fundamental analysis is a methodology that looks at the value of an asset like the GBP/USD currency pair in relation to the current socio-economic and geopolitical events that are likely to impact the asset’s price movement. An excellent example of how to use the fundamental analysis tool is to consider the latest Brexit crisis and its impact on the price of all assets linked to the UK, Europe, and Brexit.
Current news out of the UK and Europe shows that there is currently very little chance of Theresa May’s Brexit deal being passed through the House of Commons.
The final vote was due to be held before the middle of December 2018; however, it has been postponed to the week of 14 January 2019. Also, the British government has started making plans for a no-deal exit from the European Union.
Consequently, the GBP has dropped to his lowest levels in 20-months. And, it is presumed that it will remain weak until the market has priced in the worst-case scenario, or there is a positive outcome.
The most important aspect of this discourse that the trader must take note of is that the GBP price is weak and is unlikely to climb rapidly.
Although the price seems stable at its current levels, for now, there is also a good chance that it will drop again depending on how seriously the UK government pursues the no-deal Brexit option.
The Economic Calendar
Secondly, all significant financial news events like the release of employment numbers in the USA can and will impact the price of an asset linked to a CFD. If the news is expected to be positive, then the asset’s price will rise in anticipation of the good news. On the other hand, if the results are negative, the asset will drop.
Last But Not Least
This content aims to show the importance of taking all fundamental analysis scenarios into account before opening a trading position. If you do not take a careful look at the current events and news when planning your trading strategy, you run the risk of losing a substantial amount of money.
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