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Why are CFDs popular in the Forex market?
Viewed 6k times. Improve this question. Add a comment. CFDs, which stands for Contract For Difference, are financial contracts you have with your broker to exchange the difference between the opening and the closing price of a trading position.
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CFDs are leveraged financial products, allowing you to use margin trading to profit from increased market exposure. Every time you want to open a trading position, you have to put aside a fraction of the total value of this position as collateral — this is the margin.
As a result, you are able to invest more money than what you possess in your trading account. Consequently, as leverage amplifies price movements in all directions, they can be risky — you might make larger profits, but you could also lose just as much. In addition to leverage, one of the biggest advantages you have, when you trade CFDs, is that you can benefit from rising as well as falling markets, which means that you can earn money regardless of the market direction.
The Forex market is the market dedicated to currencies. It is one of the most liquid and active financial markets in the world, and it is open hours a day, 5 days a week. If you decide to trade the Forex market with CFDs, you can do so by borrowing capital from your broker to place a trade. This is called margin trading. Trading CFDs on Forex currency pairs is very popular, as it is an ideal market for leverage and margin trading due to its high liquidity, as you can enter and exit the market quite easily with small slippage.
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Of course, leverage can be offered on many different markets, but leverage, as applied to the Forex market, is generally much higher than any other trading instrument. Because CFDs are very risky leveraged products that are linked to speculation, they are not allowed everywhere. For instance, there are forbidden for US residents, but they generally are permitted in many other countries. Forex Brokers Regulations also varies in different parts around the world, as it is a fast-growing OTC market.
They only act as an intermediary between trader orders and the liquidity providers available.
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Therefore, an ECN broker only connects different market participants together, so then they can trade with each other. They only carry out trading operations, without human intervention No Dealing Desk — NDD to external liquidity providers connected to the interbank market. This means that they are the ones setting the bid and ask prices of any financial instruments offered. Therefore, a Dealing Desk broker has to pay for profitable client trades with their own money. If a client makes a winning trade, the broker loses money — and vice-versa. CFD providers are sometimes criticised for setting arbitrary spreads or suspending trading in crucial moments.
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Contracts for difference also have Rollover financing: Clients will either receive or pay financing. For instance for a CFD holder located in the UK, positions will also be priced in sterling, which makes the CFD of a foreign share or asset more attractive when sterling depreciates.
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This is unlike what happens with conventional forex dealing where the gain or loss on a currency trade is denominated in the second currency; so for instance FXADUS measures the value of one Australian Dollar in terms of US Dollars. A way to mitigate this risk with forex spot trading would be to immediately convert all foreign currency values back to your primary currency as soon as you close a trade. It is also interesting to note that forex CFDs are also traded on margin similar to forex spot trading with leverage possible up to in some cases.
In any case, the real advantages with CFDs is mainly what you can do with share trades, and the ability to trade multiple global markets from a single brokerage account.