A type of leverage trading, a contract for differences (CFD) allows investors to participate in the price movement of assets without actually buying or owning the assets themselves. It also allows investors to trade high-value underlying assets without having to put in a lot of money. Nonetheless, as a leverage product, CFDs come with many risks as we explain in this lesson.
What is a contract for differences?
A contract for differences (CFD) is a contract between a buyer and a seller stating that the buyer will pay the seller the difference between the opening trade price and the closing trade price of an asset. If the closing price is higher than the opening price, then the seller will pay that profit out to the buyer. If the closing price is lower than the opening price, then the buyer will have to pay that difference back to the seller.
Most often in this situation, the buyer is a trader and the seller is an investment firm or a broker. Contracts will typically last around a set number of days and the difference is settled in cash.
CFDs are used in leverage trading, which in this context simply means that investors borrow funds in order to make their trades, usually in the form of margin accounts with their broker. You can learn more about how leverage trading works and how experienced traders use it on the Bitpanda Academy.
What is CFD trading?
When you trade CFDs, you are not buying and selling actual assets like stocks. Instead, you are taking a position on the price movement of an asset, i.e. the expected value of an asset. CFDs deal with derivatives, which are investments that are based on an underlying asset, like ETFs, stocks or crypto, but are not that asset itself.
CFDs are traded over-the-counter (OTC), meaning they are traded via brokers. Traders can either take a long position (they expect the value of the underlying asset to go up) or a short position (they expect the value of the underlying asset to go down).
The advantages and risks of CFD trading
Since trading CFDs doesn’t involve trading the actual underlying asset, you have the advantage of investing in assets without having to buy or own them. Independent and experienced traders who want to take advantage of price movements and short-term market volatility can do so proactively with CFDs. Additionally, CFDs offer traders exposure to underlying assets at a fraction of the cost, which makes them more accessible than other forms of trading.
But as with any kind of leverage trading, that advantage is also the risk. If an underlying asset does not perform as you expected, for example the price goes up when you expected it to go down, then you could potentially incur high losses. With CFDs and leverage trading, you always stand to gain or lose the amount of total exposure, not just the amount of money you put in. Since you are borrowing money from the broker (i.e. trading on margin), you will gain or owe the debt you borrowed, the difference in value of the underlying asset plus any trading fees and interest rates.
Another downside of CFDs is that they require constant monitoring and are therefore not suitable investments for buying and holding. That is why CFDs are not recommended for traders who are just starting out.
How Bitpanda Leverage uses CFDs
Bitpanda Leverage allows investors to gain exposure and take a short or long position on the value of certain cryptocurrencies without owning them. Contrary to regular leverage trading, Bitpanda Leverage uses CFDs instead of offering the underlying asset directly.
We also offer a margin close-out protection, meaning that we will automatically close your position if 50% of your initial input has been lost. This way you can never lose more than you invest.
Real world example of how Bitpanda Leverage uses CFDs: Let’s say you want to take a long leverage position on Bitcoin at a 2x ratio. We’ll call it BTC2L. Taking this position means that you expect the price of Bitcoin to go up. Once you hit the “Buy” button in the Bitpanda app, you enter into a CFD framework agreement with Bitpanda. If the price of Bitcoin does in fact go up, let’s say by 10%, then the value of your short leverage position BTC2L will go up 20%. When the contract closes at the end of the day, you will have received the difference in price as a profit.
You can learn more about Bitpanda Leverage here.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when trading in CFDs. You should consider whether you can understand how CFDs work and whether you can afford to take the high risk of losing your money.
Bitpanda Financial Services GmbH, and Bitpanda GmbH of Stella-Klein-Löw-Weg 17, 1020 Vienna, Austria, are licensed and regulated by the Financial Market Authority, Austria, (license number GW5000.970/0006-PGT/2019 and W00861/0001-WAW/2020 respectively).
The present does not constitute investment advice. Past performance is not an indication of future results.
You should seek advice from an independent and suitably licensed financial advisor and ensure that you have the risk appetite, relevant experience and knowledge before trading. Under no circumstances shall Bitpanda have any liability to any person or entity for (a) any loss or damage in whole or part caused by, resulting from, or relating to any transactions related to CFDs or (b) any direct, indirect, special, consequential or incidental damages whatsoever.
This article does not constitute investment advice, nor is it an offer or invitation to purchase any digital assets.
This article is for general purposes of information only and no representation or warranty, either expressed or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of this article or opinions contained herein.
Some statements contained in this article may be of future expectations that are based on our current views and assumptions and involve uncertainties that could cause actual results, performance or events which differ from those statements.
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Please note that an investment in digital assets carries risks in addition to the opportunities described above.