Speculating with Contracts for Difference
In this lesson, we will look at how retail traders speculate on the direction of exchange rates
through CFDs (contracts for differences).
Understanding CFDs
A CFD is a contract between the buyer (trader) and the seller (broker) which allows traders to
speculate on the price movement of an asset without actually owning the asset. Here are the
main features of CFDs:
1. CFDs are derivative products: With CFDs, traders can speculate on both prices going
up and prices going down on underlying financial instruments.
2. Long and short positions: Traders can profit from both rising and falling prices. They
can enter a long (buy) position if they expect the exchange rate of a currency pair to
go up (buy the base currency and sell the quote currency). If they expect the exchange
rate to go down, they can enter a short position (sell the base currency and buy the
quote currency).
How CFDs work
The CFD is a contract between two parties: the trader (buyer) and the broker (seller). Basically,
the contract states that the seller will pay the buyer the difference between the current value
of the underlying asset and its value at “contract time”. If the value of the asset decreases,
the buyer pays the seller the difference.
In our next lesson, we’ll take a closer look at how margin and leverage work.