Contracts for difference can be a great way to use bitcoin and litecoin to invest in stock, commodity, and forex markets. Before you delve in, though, there are some important terms you will need to be familiar with as well as specific risks of CFDs that you need to consider.
First off, you may have heard traders talk about either “going long” or “going short” on a position, but not known what that meant.
Going long : “Going long” is what most non-financial people would simply call “buying.” You simply buy an investment, possibly with leverage (which is talked about below) and hope that the price will go up so that you can make a profit on it.
Going short : “Going short” or “selling short” is a little bit more complicated. In the simplest terms, it is just a way of betting that the price will go down on an investment. In order to go short, you must first borrow an investment, which is usually done behind the scenes by your brokerage, sell it and hope that the price goes down before you buy it back to repay the loaner.
Going short is one of the things that is a little bit different in the CFD market than in most others. CFD brokers actually sell you the contracts directly when you place a buy order and buy the contracts when you place a sell order. So, to go short in the CFD market, you can just sell the CFD to your broker and hope the price of the underlying asset goes down before you buy it back.
Leverage : Another important concept is leverage. Leverage is a method of using borrowed funds to magnify the effect of an investment. It will be easiest to illustrate with an example:
You may have seen that the leverage for the BTC/USD pair on Plus500 is 1:17. You have a hunch that the price of bitcoin is going to go up against the U.S. Dollar, but only have enough money to earn a very small amount even if the price goes up dramatically. Luckily, with the 1:17 leverage, you can borrow as much as 17 times the amount of your small investment.
This means that you can earn 17 times what you would earn with just your original investment, the difference between a new car and a new house. It’s important to keep in mind that leverage will magnify losses as well as gains you could lose 17 times more money in a trade than you would have otherwise with leverage.
Spread : Another important concept to understand when trading contracts for difference is the “spread.” The spread is the difference between the “bid” price, or the price that buyers are willing to pay at any one time, and the “ask” price, or the price for which sellers are willing to sell at any one time.
The spread is a very important concept for your broker. CFD brokerages use the spread to make money instead of charging commission on trades. They can do this because, unlike brokers that buy and sell on behalf of their clients the open market, CFD brokers trade directly with clients. They make money by offering a lower price to sellers, the bid price, than they offer to buyers, the ask price.
It’s important to keep an eye on the spread when trading. Various factors will effect how large the spread is, and you’ll need to earn more than the spread in order to make a profit. For instance, on a CFD with an ask price of $20 and a bid price of $25, the price would have to move $5 in order for you to just break even.
Risks Involved : Trading in contracts for difference (CFDs) is an inherently risky way to invest your money. Prices sometimes move in unpredictable and erratic ways. To make matters worse for the inexperienced trader, leverage can quickly make small losses into catastrophic blows to your investment capital. This is why it so important to always have a strategy when trading, and a vital part of every strategy is the price at which you will take profits on a winning trade or sell out of a losing trade.
That’s exactly what the aptly named take-profit and stop-loss are for. These fields give you the opportunity to set up a point at which a trading position will automatically be closed if it reaches a certain amount of profit or loss. A great way to hedge against a sudden price decline or rise that occurs when you are not watching your investment, I strongly recommend that you use them. Without these measures, you likely will lose significantly more than you would have on some trades, and miss out on profiting from others.
Contracts for difference can be a great way to invest your bitcoin or litecoin in the stock, commodity, and forex markets. Before you begin, you’ll need to first familiarize with a few terms as well as develop a trading strategy that limits your risk to an acceptable range for you. Once you feel ready, it’s time to dive in. Happy trading!
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