From its measly at inception in 2009 to breaking new price barriers, no person could have imagined the success of Bitcoin as an investment. Those who traded heavily and cashed in on it at the right time are now millionaires. Today, Bitcoin has evolved further, transforming into a new asset class that’s not just a currency for trading. Here, we will discover how Bitcoin can be traded as a CFD and what it entails for investors.
What are CFDs?
As its name implies, CFD or contract for difference trading is an agreement between a trader and broker to settle on the difference between the prices of an asset without actually owning it. Like stock trading, a trader can speculate on the price of an asset and anticipate whether it will rise or fall. Based on that, traders can make profits. CFDs can work on any asset class like currencies, stocks, precious metals, and of course, Bitcoin.
Example of a CFD
How Bitcoin CFDs work can be easily illustrated using the example below:
- Approach a Bitcoin CFD broker such as eToro or BitQT via their websites. You might need to install their app for access to the trading platform.
- Using their app, you can open a position, meaning you agree to join the agreement based on the current price of Bitcoin. Decide if you want to go long or short, how many units you want to buy, whether you want to leverage the amount or not, and what kind of fees you have to pay.
- After both parties agree, the position gets opened. Now it’s just a waiting game.
- Depending on the price of the asset, you can choose to keep your position open as long as you want. However, you might need to forcefully close it if experiencing a loss. When you close your position, you earn profit or sustain a loss depending on the price of the Bitcoin at that moment in time.
Advantages of CFDs
In the previous section, we saw the term “leverage” being used. This is one of the biggest advantages when it comes to CFDs. Leverage is how much access to the market you get when you trade on a margin account rather than buying the asset for the same money. Say a Bitcoin CFD is priced at $10 per unit, and you only had $100 to invest. If you buy the CFD with the money you have on hand, you can only buy 10 CFDs, but with a margin account leveraged at say 3:1, you get $200 additional dollars from a lender, allowing you to buy 30 CFDs. If the price of Bitcoin goes in your favor, you get to keep the profit after returning the original amount to the lender.
Additionally, we saw in the previous section that you can go long or short. What does that mean? If you’re a novice investor, it means you can bet on both the increasing and decreasing price of Bitcoin, just like with stock trading. But, as we will see in the next section, you must carefully navigate short positions.
The Disadvantage of Bitcoin CFDs
You have to make responsible decisions when investing in any asset. Most traders don’t realize the loss potential when trading at a short position, as theoretically, the price of Bitcoin can go up to any value. Say if you were trading CFDs at a margin on a short position and the price of Bitcoin suddenly rose due to high volatility, your losses will magnify due to the leverage you received.
Your trading app may not give you time to recover your loss when the price of Bitcoin falls. Instead, it will initiate a margin call whereby it will forcefully close your position to prevent the risk of further loss. You’ll have to owe the money you borrowed from the lender and may have to settle for a hefty loss.