The following article will explain why you should have CFDs on gold in your portfolio. The article also answers questions about what CFDs are on gold and how to trade a contract for a difference (CFD) in gold. Let’s start with an explanation regarding yellow metal’s popularity.
Gold CFDs: Why is gold so popular?
Gold has always been considered a valuable commodity, and with good reason. Gold is a sought-after precious metal in many sectors and an ideal hedge against financial market risks, especially in macroeconomic and geopolitical uncertainty. In general, there is strong global market demand for gold, making it one of the world’s most actively traded CFD commodities.
If you want to trade gold, you have several options. You can invest directly in physical gold by purchasing bullion from gold dealers or by buying gold through Exchange Traded Funds (ETFs) that hold the commodity.
Alternatively, you can trade gold through ETCs, which track the movement of the commodity or buy gold CFDs (contracts for difference), which track the asset’s underlying price. The latter is one of the most popular ways to trade gold, and it’s easy to see why. All you need to know is how trading gold CFDs works.
How does gold CFD trading work?
A gold contract for difference (CFD) is a derivative that allows you to trade the underlying asset, i.e., the price of gold, without taking actual ownership of the commodity. The good thing about CFDs is that you can always enjoy all the profits as if you owned the gold.
Trade CFDs on gold
In addition, CFDs are traded on margin. Giving you greater exposure to the gold market for only a fraction of the amount it takes to buy physical gold. Gold trading works similarly to forex trading. The trading code for gold on trading platforms is XAU, and the most popular gold exchange rate is in US dollars per troy ounce and is referred to as XAU/USD.
Other CFD exchange rates vary widely by the broker but include denominations in Euro (XAU/EUR), British Pound (XAU/GBP), Japanese Yen (XAU/JPY), and Swiss Franc (XAU/CHF).
CFD trading on gold is all about profiting from gold price movements. Consequently, success in the gold market depends heavily on your ability to predict and analyze market movements. One of the critical elements that will help you make gold price predictions is your understanding of the factors that affect the commodity’s price.
Factors affecting the price of gold
Supply and demand
As with any asset class, the law of supply and demand has a powerful impact on the price of gold. When supply is high, and demand is low, prices tend to fall. Conversely, prices often rise when supply is low, and demand is high.
Demand for gold generally outweighs supply, which has helped keep gold’s high value fairly constant over time. This fact makes gold unique compared to other commodities where supply and demand significantly impact price.
The mood of the market
Market sentiment around gold has significantly impacted gold prices more than supply and demand. Investor and public sentiment is a key price driver. Gold is popular with investors for its ability to preserve value and minimize volatility.
Therefore, gold prices are likely to rise when the market is generally bearish and uncertain. In other words, a bear market tends to create a bullish stance on gold.
Economic and geopolitical framework
Strongly tied to market sentiment, financial crises and political instability create uncertainty contributing to gold price movements. Gold prices hit an all-time high in 2011 as the eurozone debt crisis ravaged the continent. Similarly, in mid-2019, gold prices rose amid escalating tensions in the US-China trade war. In both cases, investing in gold provided some stability and increased the value of the commodity.
Gold prices tend to perform well during times of global economic turmoil and political uncertainty as investors invest in gold’s “safe haven” status. In addition, it affects the economic condition.
Notice! In times of economic recession or depression, many investors forgo relatively high-risk investments, such as stocks, in favor of investing in a relatively safe asset like gold. This circumstance drives up the value of the raw material.
Currency rate movements
Gold is mostly traded in US dollars, and the dollar strongly influences the price of gold. While not always the case, gold has a somewhat inverse relationship with the US dollar; when one increases, the other decreases.
Inflation and deflation
When currencies become unstable during periods of high inflation or deflation, many investors turn to gold to hedge their returns, increasing the commodity’s price. If there is little or no inflation, the price of gold will likely fall.
Although there is no direct correlation between interest rates and gold prices, and it is not uncommon for both to move in the same direction, higher interest rates tend to drive down the price of gold.
This is because the higher interest rates offer higher returns for investors putting money into savings, essentially making gold less attractive to investors and removing liquidity from the gold market. Interest rates are also a strong indication of how central banks are regarding inflation, which sometimes affects the price of gold.
Why you should trade gold CFDs
While buying physical gold can involve time-consuming processes, setting up a CFD trading account is relatively easy and quick. Buying gold is also quite expensive – the price of a gold bar average over USD 50,000. Unless you have a lot of cash, trading gold CFDs is an inexpensive way to access and participate in the gold market.
Daily gold trading volume is estimated to be around US$70 billion, exceeding that of most currency pairs (excluding EUR/USD, GBP/USD, and USD/JPY). The considerable trading volume gives Gold CFDs high liquidity.
This high level of liquidity means that gold CFDs are cheaper to trade than other financial instruments, and the commissions charged are usually tiny. Additionally, the high level of liquidity makes selling CFD contracts easy, which brings us to the next benefit.
The ability to go long or short
Trading gold CFDs means you don’t have to worry about timing your trades when the market is rising. The high liquidity of gold CFDs means you can benefit from price movements in both rising and falling markets. If you think the price of gold will rise against a currency, go long (buy) and if you think the price of gold will fall against a currency, go short (sell).
Because CFDs allow traders to profit even when markets are down, gold CFDs are an advantageous tool. They can provide traders with stability and a chance to thrive even in unstable markets.
CFDs are leveraged financial products. You can deposit the total amount required to open a position. Gold CFDs typically have high leverage, which translates into low-margin requirements.
For example, if you get 50:1 leverage on a $50,000 position, you only need to deposit $1,000 into your account. With the low margin, you can open the entire contract for $50,000. Accordingly, you would only need to deposit $500 with a leverage of 100:1.
The gold market is very volatile, and its price tends to fluctuate more than traditional currency pairs like the EUR/USD. The pair sees price movements of around 50-100 pips almost daily. This high volatility gives traders more opportunities to succeed in the gold market.
No contract expiry date
Gold CFDs have no expiration date, and a trader decides when to close a position. This is beneficial as you can hold an open position until the desired profit range is achieved.
What are the disadvantages of trading gold CFDs?
While trading gold CFDs offers traders several benefits, it also comes with some risks.
The demands of a volatile market
Since investing in gold is considered a safe haven when stock markets are unpredictable, high market volatility may only sometimes work well. A slight market movement can greatly impact the price of gold and result in considerable losses.
Even with highly volatile markets, the likelihood of a sudden downturn is high, so you need to monitor and keep a close eye on your margin level. In addition, you may also have short-term CFD margin requirements to meet, and failure to comply with them may result in your position being closed out without notice and at a loss.
The cost of holding a position for an extended period of time
Although the CFD holder usually tries to profit from short-term price movements, some traders choose to hold their positions for more extended periods. In this case, brokers can apply rollover rates to keep positions open, which can become very costly in some circumstances and in the long run. Understanding the actual cost of holding a position before executing it is essential, as sometimes the results need to justify the cost.
How to start trading gold CFDs
Trading Gold CFDs is similar to trading any other financial instrument – you need to know how to navigate the market. The CFD market is complex, and it will take time to grasp all of the market dynamics, but you can get started in just a few steps.