Why and How Should You Use CFDs for Forex Trading?

Until the Covid-19 pandemic began, the Forex market had seen generally decreasing volatility over the preceding decade. Central banks kept interest rates near zero and flushed markets with liquidity, all of which led to suppression in currency fluctuations. However, things changed once the pandemic began, since unprecedented fiscal and monetary support revived the currency market.

Currency markets increasingly active

Activity has gradually settled as market fears related to the pandemic shifted into the rearview mirror. However, some analysts believe things might be changing once again as currency volatility could make a comeback.

trading in the FX market
trading in the FX market

Given such circumstances, you should be aware that it is possible to get involved in the Forex (commonly referred to as FX) using online brokers, covering a wide range of currency pairs. FX trading has been popular among retail traders mainly because this is the largest and most liquid market in the world, which means the ability to gain access to tight trading costs and rapid trade execution.

The near-term future will come in hand with new challenges, such as coping with high inflation, high levels of debt-to-GDP, or social unrest, all of which could end up having a major impact on financial markets, including currencies.

Using CFDs like a pro

One of the popular instruments used by FX traders are Contracts for Difference (CFDs), derivatives that mirror the performance of the underlying asset. You can use CFDs to spot short-term trading opportunities, ideally when the price has a clear directional bias.

Because traders usually only need to pay the spread as the main trading cost, CFDs happen to be attractive as long as there is volatility. However, these instruments aren’t often used for long-term trading, given traders may be charged an overnight swap for each day they hold an open position.

Managing risk

As with any other endeavor in the financial industry, Forex trading comes with risks. Traders will have to learn how to manage it for their benefit and that can be done using techniques and methods widely available. One of the popular ones is the usage of stop losses, in order to limit downside exposure when markets are evolving not as expected.

Diversification is another tool traders can use when trading FX. According to Reuters, inflation is one of the top concerns among investors and since its effects can’t be fully anticipated, preparation for different scenarios is necessary. Some may choose to build a list of currency pairs and constantly trade on them, with adjustments allowed when major market changes lead to other currencies being more active.

Summary

Although the focus has been on stocks and cryptocurrencies due to higher volatility, FX trading should not be completely neglected. In fact, periods of outperformance are usually followed by poor returns, which might mean currency trading might be increasingly attractive in the near future.

Central banks are committed to keeping currencies stable, but if inflation remains elevated, they won’t be able to act against their mandate (price stability). Using CFDs based on FX are, thus, useful tools in this uncertain world.