Most people trade cryptocurrencies through cryptocurrency exchanges, there is, however, another option with which one can speculate on price movements. This can be done by using contracts for difference (CFDs). In order to fully understand the potential of CFD instruments in cryptocurrency, we need to take a closer look at CFDs.
CFDs are financial derivatives which are conducted as agreements (contracts) between a trader and a brokerage company. When we have a contract, we do not actually own the underlying asset, instead, we possess the right to receive the difference between the current value of an asset and its value in the future. If our prediction on the value of the underlying asset is incorrect, and the difference is negative, the trader will have to cover that loss. CFDs can be created for shares, indices, forex, and also cryptocurrency. With CFDs, traders can speculate on the price growth and price decline of an underlying asset. There is a great guide to cryptocurrency trading which explicitly focuses on crypto trading with CFDs.
Leverage is a tool that is used to trade with more capital than a trader actually has. In practice, this means that, when you open a cryptocurrency position with a $500 investment, and you use 5:1 leverage, you do not trade with only $500, but with 5 times the amount of capital — 2,500$. As a result, you can make more money even with small price movements. That being said, the risk of losing your money is also much higher, and every price movement in the opposite direction can significantly hurt your funds. Therefore, one has to think carefully about whether leverage trading is suitable for his or her trading style. Almost every CFD broker offers leverage. All regulated brokers, by the European regulator CySEC, have a maximum leverage for cryptocurrencies of 5:1. Most cryptocurrency exchanges do not support leverage trading, apart from Bitmex, Kraken, and Poloniex, where leverage trading can be used only with certain cryptocurrency pairs.
CFD instruments can also be traded using stop loss and take profit tools. These features come in handy when you take into consideration how extremely volatile the cryptocurrency market can be. By creating a stop loss order, you determine at what price level your position should be closed, so no further losses can occur. On the other hand, take profit allows you to safely lock in profit before the price of the underlying asset declines. Both stop loss and take profit are very important features that are crucial when trading cryptocurrencies. One should set them at a price level that will not be triggered all the time, in which your capital can be destroyed (bear in mind the volatility of the cryptocurrency market).
CFD trading is usually regarded as a better option for day trading cryptocurrencies because the spreads are usually lower. There is, however, usually a swap fee which brokers charge when traders stay in a position overnight. Due to this, most CFD brokers are not suitable for long-term investing and holding. Cryptocurrency exchanges do not have swaps, so long-term investing is ideal here. One buys cryptocurrency, and holds it for however long he or she prefers, and then sells it for fiat currency, or exchanges them for other cryptocurrencies. The bigger spreads here are negated by a substantial increase in value.
Customer support may prove useful when you need guidance on how to execute a trade or set up an account. All CFD brokers do have a customer support that can usually be contacted by email, live chat, or mobile. Most cryptocurrency exchanges do not have customer support, and traders need to resolve their problems on their own. While customer support will not answer questions on how you should speculate on cryptocurrencies, or what trading strategies are best to use. It is still a very good advantage, especially when you have questions regarding withdrawing or depositing funds.
There is no final answer to if CFD trading is better than trading on an exchange, because it all comes down to a preferred style of trading. Both options can bring impressive results. CFDs are, however, more suitable for day traders who like to enter a position, and then quickly exit.
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Author: Michael Kuchar
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