Throughout history, gold has always been seen as a valuable commodity, and for good reason. In addition to being an in-demand precious metal in many industries, gold is an ideal hedge for financial market risks, especially during periods of macroeconomic and geopolitical uncertainty. There is generally strong global market demand for gold making it one of the most actively traded commodities in the world.
If you want to trade gold, there are several options open to you. You can directly invest in physical gold by purchasing gold bullion from bullion dealers or through gold exchange-traded funds (ETFs) that hold the commodity. Alternatively, you can trade gold through ETFs that track the movements of the commodity or purchase gold CFDs (contracts for difference) which track the asset’s underlying price. The latter is one of the most popular ways of trading gold and it’s quite easy to see why when you know how trading gold CFDs works.
How Does Trading Gold CFDs 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 still get to enjoy any gains as if you owned the gold. Additionally, CFDs are traded on margin thereby giving you greater exposure to the gold market for only a fraction of the amount you would need to buy physical gold.
Trading gold works similar to forex trading. The trading code for gold on trading platforms is XAU and the most popular gold exchange rate is denominated in US dollars per troy ounce and denoted as XAU/USD.
Other CFD exchange rates largely vary by broker but include denominations in Euro (XAU/EUR), British pound (XAU/GBP), Japanese yen (XAU/JPY), and Swiss francs (XAU/CHF).
Gold CFD trading is all about trying to capitalise on gold price movements. Consequently, success in the gold market relies heavily on your ability to predict and analyse market movements. One of the key elements that will help you with gold price predictions is your understanding of the factors that affect the price of the commodity.
What Influences the Price of Gold?
There are several factors that influence the price of gold,
here are some common ones.
1. Gold Supply and Demand
As with any asset class, the law of supply and demand has a strong influence on gold prices. When supply is high and demand is low, prices tend to go down. Conversely, when supply is low and demand is high, prices tend to increase. The demand for gold generally outweighs the supply and this has helped keep the high value of gold fairly consistent over time. This makes gold unique to other commodities where supply and demand have a more substantial effect on price.
2. Market Sentiment
The market sentiment surrounding gold has had a bigger effect on the price of gold compared to supply and demand. The sentiment among investors and the general public is a significant price driver. Gold is popular among investors for its ability to maintain value and minimise volatility, therefore, if the market is pessimistic and uncertain in general, the price of gold is likely to increase. In other words, a bear market tends to create a bullish stance on gold.
3. Economic and Geopolitical Conditions
With strong ties to market sentiment, financial crises and political instability create uncertainty that contributes to gold price movements. For instance, gold prices hit an all-time high in 2011 when the Eurozone debt crisis was wreaking havoc on the continent. Similarly, in mid-2019, gold prices increased amidst the escalating tensions in the US-China trade war. In both cases, investing in gold provided some stability and this increased the value of the commodity.
Gold prices tend to perform well during times of global economic unrest and political uncertainty as investors buy into gold’s ‘safe haven’ status. Additionally, economic conditions affect gold prices. During periods of economic recession or depression, many investors drop investments with relatively higher risk, for example, equities, for safer assets like gold and this drives up the value of the commodity.
4. Currency Movements
Gold is largely traded in US dollars and so the dollar has a strong influence on the price of gold. Although not always the case, gold has a somewhat inverse relationship with the US dollar; when one increases, the other decreases.
5. Inflation and Deflation
When currencies become unstable during times of high inflation or deflation, many investors turn to gold to secure their returns and this increases the commodity’s price.
When there is little or no inflation, gold prices are likely to go down.
6. Interest Rates
Although there is no direct correlation between interest rates and gold prices and it’s not uncommon for both to move in the same direction, higher interest rates tend to lower gold prices. This is because the higher interest rates offer higher returns to investors putting money into savings, essentially making gold less attractive to investors and taking money out of the gold market. Interest rates are also a clear indication of how severe central banks think inflation is and this sometimes has an effect on gold prices.
Why Trade Gold CFDs?
Gold CFDs have gained popularity in the financial markets because they afford traders many benefits. Some of the biggest ones include:
While buying physical gold may involve some time-consuming processes, setting up a CFD trading account is relatively simple and quick. Buying gold is also quite expensive – the price of one gold bullion averages upwards of $50,000. Unless you have a lot of money at your disposal, trading gold CFDs is a cost-effective way to access and take part in the gold market.
It’s estimated that daily gold trading volumes are around $70 billion and exceed those of most currency pairs except EUR/USD, GBP/USD, and USD/JPY. The high trading volume gives gold CFDs high liquidity. This high liquidity means that gold CFDs are less expensive to trade compared to other financial instruments and the commissions charged are usually very small. Additionally, the high liquidity means selling CFD contracts is easy, which brings us to the next benefit.
The ability to go long or short
When trading gold CFDs you don’t have to worry about timing your trades for when the market is rising. The high liquidity of gold CFDs means you can capitalise on price movements in both rising and falling markets. If you think that the price of gold will increase against a currency, you go long (buy) and if you think that the price of gold will weaken against a currency you go short (sell).
Since CFDs allow traders to benefit even when the markets are falling, gold CFDs are an advantageous instrument. They can offer traders some stability and a chance to succeed even in unstable markets.
CFDs are leveraged financial products. You don’t need to deposit the full amount required to open a position. Gold CFDs tend to come with high levels of leverage, which translate into low margin requirements. For example, if you get 500:1 leverage on a $500,000 position, you will be required to deposit only $1,000 into your account to open the full $500,000 contract.
The gold market is highly volatile and its price tends to fluctuate more than traditional currency pairs such as the EUR/USD which sees price movements of around 50-100 pips almost every day. This volatility gives traders more opportunities to succeed in the gold market.
No contract expiration date
Gold CFDs have no expiration date and a trader chooses when to close a position. This is beneficial as you can keep an open position until you get the desired profit margins.
What Are The Drawbacks of Trading Gold CFDs?
While trading gold CFDs offers traders several benefits, there are some risks attached to it.
The risk attached to using margin
Gold CFDs are traded on margin using leverage, which means that a trader’s profits are magnified. However, the same leverage that increases the amount of return can also magnify losses which is why it should be used with caution.
The demands of a volatile market
In as much as investing in gold is considered a safe haven when the stock markets are unpredictable, the high market volatility may not work well all the time. A slight movement in the market can have a great impact on the price of gold and this can result in big losses.
Also, when markets are very volatile the chances of experiencing sudden downturns are high and this means that you have to keep a close eye on and maintain your margin level. Not only that, but you may also have to satisfy margin calls on short notice, failure of which may lead to your position being closed without notice and at a loss.
The cost of holding a position for a long time
Although the CFD market usually involves trying to profit from short-term price movements some traders may choose to maintain their positions for longer periods. When this happens, brokers may apply rollover rates for keeping the positions open and in some cases, this can become very costly. It’s important to understand the true cost of holding a position before going through with it because sometimes the results do not justify the costs.
How to Start Trading Gold CFDs Trading gold CFDs is similar to trading other financial instruments – you need to know how to navigate the market. The CFD market is complex and it will take some time to get a good grasp of all the market dynamics, but you can get started in a few steps.
Step 1 | Learn the market
Gold CFDs involve dabbling in both the commodity market and CFD trading. You need to have a proper understanding of both. Learning the gold CFD market is a crucial step that will help you familiarise not only with the different factors that move the market but all the fundamentals required to navigate the market such as how you analyse the market and the common CFD mistakes that lessen your chances of succeeding.
Step 2 | Have a plan
As the well-known expression goes, ‘failing to plan is planning to fail’. Like in any other financial market, a robust plan is crucial when trading gold CFDs. The plan needs to include some essential elements including your trading goals, risk appetite, preferred analysis method, trading strategy, and money and risk management tools. It’s especially important to detail the analysis method, the strategy, and any money and risk management rules.
Step 3 | Analysis method
The two most common methods of analysing gold prices are technical and fundamental analysis. Fundamental analysis is based on studying macroeconomic data and market sentiment to try and forecast price movements. Traders attempt to analyse the dynamic world economics such as inflation, political uncertainty, and negative real interest rates. They then use the information to make educated decisions on where to position themselves in the market. Technical analysis involves studying past price movements and patterns to predict possible future movements and trends. This is done using price action, chart patterns, and technical trading indicators. Whichever analysis method you choose will help you create a sound strategy that includes your entry and exit levels. It’s also possible to use a combination of both technical and fundamental analysis when analysing the market.
Step 4 | Risk and money risk management
Once you know your entry and exit levels, you should also have some risk and money management rules in place. The rules should include how much of your capital you will risk with each trade, the maximum loss you are willing to incur per trade, and your risk/reward ratio so that you have a balanced investment portfolio. You will also need to plan how you will minimise the risk inherent in gold CFDs once you open a trade. This may include an outline of how you will use stop-loss and limit orders to minimise large losses and the risk that comes when the market suddenly moves against you, especially during periods of high volatility. The quality of your plan will rely heavily on the knowledge you have about the market. For example, if you don’t know how slippage affects trailing stops your plan may not include using guaranteed stops to minimise your risk. Furthermore, formulating and following a plan is more important than having a plan you don’t follow. Following your plan will instil discipline, an important element for any trader who wants to become consistently profitable in the long run.
Step 5 | Choose a Good CFD Broker
Not all brokers were created the same. Some brokers will help you achieve your trading goals while others will greatly reduce your chances of succeeding in the market. Before you start your gold CFD trading journey you should choose a reliable broker who offers quality service and support. Some of the top things to look out for when choosing a broker include:
Regulation. A regulated broker means that your funds are secure since regulating bodies stipulate that trader funds be kept in segregated accounts. Regulation also goes beyond the money in your account and means that your broker is required to keep your personal and financial information secure.
Trading costs. You should opt for a broker who can offer you competitive commissions and ultra-tight spreads without sacrificing the quality of their brokerage services.
Trading platform choices. Price movements in the gold CFD market can be quick especially during highly-volatile periods and a good platform can be the difference between executing your trades well or incurring losses. A good broker will offer you a selection of robust platforms with good tools and technology to help enhance your trading.
Margin and leverage requirements. Different brokers have different minimum margin requirements. You need to choose a broker who has a deposit requirement that aligns with how much you are willing to spend in the market and offers a minimum leverage level that best suits your trading abilities and goals.
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