Derivatives became a prominent part of global trading in the 1980s. It initially started out as commodities trading on agricultural commodities such as cocoa, coffee, and wheat. Currently, the derivatives trading market is a large global market and you can learn to trade derivatives.
What Is a Derivative?
Simply put, a derivative is an investment that depends on the value of some other thing. It is financial security, and the value is derived from or reliant upon an underlying asset or group of assets. Examples of such underlying assets are bonds, stocks, interest rates, currencies, and market indexes. Typically, these underlying assets are purchased through brokerages.
Derivatives are usually leveraged instruments and this increases their potential rewards as well as risks.
How To Trade Derivatives
There are two ways to trade derivatives; one is through regulated exchange offering standardized contracts. The exchange acts as an intermediary that helps traders avoid counterparty risks that come with unregulated over the counter (OTC) contracts.
The second way to trade derivatives is by over the counter (OTC) derivatives. The terms of the contract is negotiated between the parties in a non-regulated market. The contract is a non-standard contract.
One of the most widely used derivatives is the CFD (contracts for difference).
CFD, also called Contract for Differences is an arrangement made in financial services trade where differences on the settlement between open and closing trade prices are settled with cash. It is an advanced trading strategy which experienced traders use. CFDs are popular among foreign exchange and commodities products.
How To Trade CFDs
CFDs trading require low capital. To trade CFDs you speculate on whether an asset’s price will move down or go up without having to own the asset itself. In CFD trading you speculate on price movements in any given direction.
Trading CFDs has a number of benefits including:
With CFDs trading, your investment capital can go further because you are only required to deposit a fraction of the value of your trade to open a position. The required deposit is called a margin, but your profit or loss is based on the full size of your position, not the margin.
2. Going Short
CFD trading is more flexible than other forms of trading because it consists of an agreement to exchange the difference between the opening and closing price of the position. Therefore you can trade in markets headed down as well as those going up.
When you trade CFDs, on the platform you will see listed the sell price and buy price. If you reckon the price of the market is going to go down, you trade at the sell price. However, if you feel that the price of the market is going to go up, you trade at the buy price.
- Access to Thousands of Markets
Another advantage of CFD trading is that you can use CFDs to trade in over ten thousand markets including indices, forex, commodities, options, shares, and crytocurrencies. All this can be done from one account and you can do it online using your computer, phone, or tablet. You can make trades outside traditional trading hours.
3. Hedge Your Share Portfolio
With CFD trading, you can hedge your share portfolio and offset potential losses using CFDs by opening a short position.
4. Direct Market Assess (DMA)
Advanced traders can get direct market access (DMA). It enables traders see and interact with order books of forex providers and stock exchanges. So you can see all available offer and bid prices and trade at market prices. You should note though that this is only recommended for advanced traders.