Cryptocurrency CFDs 101, Your Complete Guide
You may or may not have traded cryptocurrencies before. If you have then you most likely will have used a cryptocurrency exchanges.
These are essentially large centralized platforms that provide for a platform where you can place an order to buy or sell a cryptocurrency. They will run a large order book and make the market for you. When you buy a coin on this exchange, you are buying the actual coin.
If you are the person who wants to buy the coin as a means to store it in a wallet on your PC then that is all well and good. However, there are many people who like to trade these currencies on a daily basis.
They would also like the opportunity to take the opposite side on a trade and short sell them, thereby making a profit on the fall of the currency. This is where you can consider other investment instruments.
The most prominent of these is a CFD. Let’s take a look at what this is.
What is a CFD?
A CFD is a Contract for Difference. Essentially, it is a derivative instrument. This means that it derives its value from the value of some other asset. In this case, that asset is a cryptocurrency.
In the case of a CFD, the investment product is a contract on the difference in price of a cryptocurrency at the beginning and the end of the day. This is market to market every day and the trader’s account is margined.
The most important point about a CFD though, is the fact that the asset can also be short traded. This means that the trader can make a profit in the case of a fall in the price of a cryptocurrency.
CFDs have been around for a number of years and are not too dissimilar from other derivative products such as spread betting. This is because you are, in the end, betting on the spread of a particular asset.
So now that you have an idea of what a CFD is, you have to find the best broker with whom to begin trading these CFDs. This is also not a clear cut move.
Finding the Broker
One thing that is known in cryptocurrency trading is that the amount of fees a broker charges you will impact on the profitability of your trading in the long run. Brokers will drive the spread that you get in on the asset.
Similarly, you want to make sure that you trade with a broker that is offering you the most options in the way of assets. Some brokers only have a limited amount of cryptocurrency pairs for your to trade with.
And, most importantly, you have to make sure that the broker that you are using has some sort of regulatory oversight. One of the best cryptocurrency CFD brokers is IQ Option. They are fully regulated in Europe. You can read more in this IQ Option broker review.
Deciding Which Crypto
Once you have set up your account at a broker, you have to decide on the cryptocurrency that you are going to trade. While there are hundreds of cryptocurrencies that you can trade, there are less than can be done with a CFD.
Hence, you need to make sure that you are comfortable with the pair in question. Some of the most common cryptocurrencies that you can trade CFDs with are Bitcoin, Ethereum, Ripple and Monero.
It also makes sense to select a cryptocurrency that is not as susceptible to periods of intense illiquidity. This will mean that the price will unexpectedly gap and blow through any of the stops that you may place (more below).
Knowing what Drives Price
Before you can effectively trade cryptocurrencies with CFDs, you have to know what factors are likely to drive the price in the short and the long term. These factors could include macro factors, technological changes and of course technical price factors.
When looking at the macro factors you have to take into account what the general market is feeling in terms of risk aversion and avoidance. These factors are likely to impact on how many people will invest their funds in cryptocurrency and drive the price.
In terms of the technological factors, these are very important especially for something like a cryptocurrency. As these assets are built on top of technology, any changes that happen to the protocol or the mechanics of the blockchain is likely to impact on the price.
Lastly, price action can drive prices. If technical investors think that a rally is coming based on particular levels. Other factors such as momentum are also important in the movement of prices in the short term.
These factors often times can converge and impact on the price all at the same time. This is why it is very important to make sure that you know which factors are at play before you enter a position, long or short.
Always Manage Your Risk
What is important to note about CFDs is that they are levered products. This means that they are traded on the margin and price movements are likely to impact to the position much more than without the leverage.
In the case of some brokers, this can be as much as 20:1. This means that for every 1 point move in the underlying cryptocurrency, it is likely to impact your position as much as 20 times more.
With these risks in place, it is important that you have the most adequate risk management policy in place. This usually relies on you placing dedicated stop losses and take profits around positions. These are effectively automated orders that will execute the moment that the price reaches a certain level.
They serve the purpose of making sure that your order is executed even if you are not monitoring your position. They also are placed such that your emotions are taken out of the equation. The moment that levels are met, they will be traded on and pre-determined.
If you make these guaranteed stops then they will be executed even in the event that the market should gap for any particular reason. Trading with stops is essential if you want to be taken seriously as a trader in general.
CFDs provide traders with another instrument which can give them a certain edge on the market. They allow for entering positions that they otherwise would not have been able to enter with a pure cryptocurrency.
However, they can be a bit more risky and when trading with them it is essential to use automated stops which can prevent losses that were not foreseen. You should also study the types of factors that are likely to drive the price be they technical of fundamental.
Start small and on a demo account. Improve your trading with dedicated practice. And, most importantly, never invest more than you are willing to lose. Trading is still a risky endeavour and those who lose are those that are ill disciplined. Check out Bitcoin Starter Tips for great tips on getting started with bitcoin.