A Quick Guide on the Differences Between CFDs and the Spot Market
Many of you are already asking yourself (and us), “what is the spot market and what is a CFD?” Don’t worry if you didn’t know this already because we are going to cover the basics in understanding these two types of mechanisms for trading, why they’re different, and why we believe CFDs are better for Olymp Trade clients.
Forex trading, sometimes referred to as Fx or foreign exchange, has a variety of trading methods available for investors including the spot market, spread betting, futures, options, CFDs and more.
Let’s focus on two of the most popular methods — the Spot Market and Contracts for Difference (CFD). Both of these markets have positives and negatives depending on what your trading goals are, but we find that most of Olymp Trade’s clients prefer CFDs versus the spot market.
To understand why, let’s begin by explaining exactly what the “spot market” is and how it functions.
The spot market is a more traditional market where a seller and buyer agree on a trade price and the exchange of the two assets involved in the trade are done immediately — “on the spot”. However, this doesn’t actually get done on the spot for most assets because there is a need to arrange for the delivery of the assets.
For instance, you want to buy 100 shares of a stock for $100 USD each. The seller agrees to sell these shares to you at the price and you’re willing to pay immediately, but they need to arrange for the stock certificates to be delivered to you and they don’t have the actual certificates with them.
In this case, the norm is T+2, which means the transaction date plus 2 business days to finalize the transaction. The price agreed upon is set and will not change despite any value changes in the stock in the two days it takes to receive the certificates.
Another example would be the exchange of two currencies in the Forex market. You want to buy Japanese goods, but you need Yen to do so. Therefore, you go to an exchange and purchase Yen with your USD at the spot price and immediately receive your Yen so that you can make your purchase.
Many exchanges will conduct the transaction immediately, but if you go to a larger market, the 2 day transaction limit may apply (T+2) before you actually receive your Yen.
For commodities like oil and Gold, delivery times can take longer and often a futures contract is used to facilitate this exchange at a set time in the future.
The most significant key to the spot market is that there is an Actual exchange that takes place between the two parties.
Contracts For Difference (CFD)
What if you’re not really interested in taking delivery of an asset and are looking to sell that asset again for a profit because you believe the asset will increase in value in the future? What if you think that an asset is going to lose value in the future and are looking to profit off the decrease?
This is where CFDs can be a great financial instrument for investors and brokers like Olymp Trade have created platforms specifically for this type of trading.
With a CFD, investors can enter an agreement with their broker based on their belief in the future price of an asset regardless of whether it is lower or higher than the current “spot” price. In this case, the broker becomes the the 2nd party in the transaction instead of another investor and enters a contract for the difference in the price of an asset over time.
You believe that the price of the Canadian dollar (CAD) in relation to the U.S. dollar will increase in the near future. The Forex currency pair USD/CAD market works as the underlying market for your prediction.
If the value of the CAD increases relative to the USD, it means the amount of USD needed to buy increases so you enter a Buy order at the current price. If at any time you want to exit the transaction, you can close the agreement and take the difference between the two prices.
If the value went up, as you predicted, by $50 USD, then you would make $50 profit minus any commissions for the transaction.
You can enter Sell CFDs in the same way. The key is that the underlying asset moves in the direction that you predicted and the larger the movement in that direction, the larger your profit.
In contrast to a traditional spot trade where you actually hold the asset and trade it again to another party that is interested in buying.
Benefits of CFDs on Olymp Trade
Utilizing Forex CFDs on Olymp Trade provides traders with several advantages over the spot market.
No Need to Take/Make Delivery of the Asset
As we explained earlier, since most traders aren’t interested in holding a particular asset permanently, they can trade more easily on only the value of an asset and this reduces transaction costs and hassle.
Make Profits on Downward Movement of Markets Without Owning the Asset
The ability to profit off of downward movements of the markets is possible with CFDs without actually having to own the asset to “short” it and without the need to buy it at the quoted “short” price or time.
You can make significant profits even when the markets are going down.
Better Leverage System with Olymp Trade’s Multipliers
Using the Olymp Trade multiplier system, traders can enter CFDs at up to 500 times the amount of their investment, which makes the trade more profitable. Additionally, because the multiplier doesn’t function like typical leverage, traders are only risking their invested amount and not the borrowed (leveraged) amount.
If you enter a trade for $100 USD of your own money and Olymp Trade gives you a multiplier of 500x that amount, you will make 500 times the profit off a correct prediction on the price movement. In this case, even a small movement of only 1% in the chosen direction will achieve a $500 USD profit for the trader minus the commissions.
Best of all, if the price moves in the wrong direction, you only stand to lose your invested amount of $100 USD and you can always exit the position before your $100 USD is lost. By taking advantage of the Stop Loss function of the platform, there is significantly less risk than with the spot market because you don’t have to find another trader willing to take your price.
There are many different ways to trade in the markets besides just spot and CFD trading. This is especially true with Forex, which has variants such as spread betting, digital options, and more. However, the advantages of utilizing CFDs are pretty clear in comparison with other Forex trading methods.
It is easy to see why CFDs are so popular in emerging trading markets like Forex trading in India, Malaysia, Indonesia, Africa and South America. With only a small deposit of $10 USD, traders can take advantage of the Olymp Trade multipliers to make significant profits with reduced risk.
If you’re not utilizing the Forex side of the Olymp Trade platform already, you now have some good reasons to start.