A contract for difference (CFD) is a derivative financial instrument that allows traders to invest in an asset without actually owning it. Very popular with investors for hedging risk in volatile markets, CFDs allow traders to speculate on the rising or falling prices of assets, such as shares, currencies, commodities, indexes, etc. A bitcoin CFD enables investors to tap into bitcoin’s benefits and risks without actually owning the coin. Investors who actually hold bitcoin can also use short selling bitcoin CFD trades to offset the losses in their bitcoin portfolios, whenever BTC prices are moving down.
A contract for difference (CFD) is essentially an agreement between two parties: the buyer (the investor) and the seller (the CFD provider).
At the end of the contract, the parties exchange the difference between the opening and closing prices of the asset that makes the subject of the CFD.
The seller pays the buyer the difference between the current value of the asset and its value at “contract time”.
If the difference is negative, the buyer pays the seller instead.
CFDs are a form of derivative trading
Just like futures and options contracts, contracts for difference are derivatives. That is, CFDs allow investors to speculate on the rising or falling prices of assets – such as shares, currencies, commodities, indexes, etc. – without actually owning them. Investors can take advantage of price movements and either go short (sell) if they think prices will fall, or go long (buy) if they believe prices will rise.
With contracts for difference, you don’t actually buy or sell the underlying asset (a share, a currency pair, a commodity). You buy or sell a number of units for a particular asset. For every point the price of the asset moves in your favor, you gain multiples of the number of CFD units you bought. If the price of the asset moves against you, you lose multiples of the number of CFD units you bought.
CFDs are a leveraged product
With CFDs, investors only need to make a small deposit (typically 5%-10% for shares and 1% for indexes) in order to open a position. This is called “trading on margin”. Lower margin requirements mean less capital outlay for the investor and greater potential returns. However, they can also mean greater potential losses. Therefore, the investor could lose more than the initial capital deposited.
Unlike futures and options contracts, CFDs do not have an expiry date. A contract for difference is renewed at the close of each trading day and can be rolled forward indefinitely – if desired, providing there is enough margin in the investor’s account to support the position.
There are little to no restrictions when it comes to trading CFDs:
- No restriction on the entry or exit price of a contract for difference;
- No time limit to exchange the price difference in the asset;
- No restriction on buying first or selling first;
- Positions can be closed at anytime during market hours;
What is a bitcoin CFD?
A bitcoin CFD would track the bitcoin price and mirror its daily performance, allowing people to invest in the cryptocurrency without actually owning any, so without having to worry about the challenges of buying, storing, and safekeeping it.
Trading a bitcoin CFD is not much different from trading any other currency pair CFD. Bitcoin is known for its price volatility. However, when trading a bitcoin CFD, volatility can very well turn out to be your friend, as long as you pay attention to the market trends and act accordingly.
Advantages of trading a bitcoin CFD
- Speed: Bitcoin CFD trading is instant. Remember, you are not trading actual BTC. You are trading a contract. The trade is executed instantly, at the desired price.
- You can profit regardless of price movements: If you are bearish on bitcoin, you can open a sell/short bitcoin CFD position. If you are bullish on bitcoin, you can open a buy/long CFD bitcoin position. Regardless of the price movements, you can still profit, provided that you guess the actual price trend.
- Fiat currency: You can trade a bitcoin CFD using fiat currencies. However, if you would rather trade using crypto, there are brokers that accept cryptocurrency payments.
- Leverage: Just like any other CFD products, a bitcoin CFD is leveraged. That enables you to control a larger position and can lead to greater potential returns. However, it can also maximize your potential losses.
Using a bitcoin CFD to balance out losses in your bitcoin portfolio value
Using CFDs to hedge risk is a popular strategy for many investors, especially in volatile markets.
If you already hold bitcoin and you believe your portfolio may lose some of its value over the short term, you can use a bitcoin CFD to hedge the risk.
For instance, let’s say you hold $5,000 worth of bitcoin in your portfolio. You could hold a short position or short sell the equivalent value of bitcoin with CFDs. Then, if bitcoin’s price falls, the loss in value of your bitcoin portfolio could be balanced out by the profit made on your short selling bitcoin CFD trade. Once the bitcoin price starts to rise again, you can close out your bitcoin CFD trade to secure your profit.
Bitcoin CFD trading
Bitcoin CFDs are typically traded OTC (over-the-counter) meaning they are not traded through regulated exchanges. Due to strict rules applied to over-the-counter financial products, CFD trading is not permitted in the United States.« Back to Wiki Homepage