CFD bonds: What are they and how do they work?

Contract for difference (CFD) bonds are popular financial instruments used by traders.

In this article, we will explain the benefits and risks of CFD bonds and how traders can use a CFD bond's price determinants to anticipate the market.

What are CFD bonds?

CFD bonds are financial instruments offered by CFD brokers that enable traders to speculate on the price movements of reference assets. The assets used as reference can be corporate or government bonds.

CFD bonds allow traders to potentially profit from the difference between the opening and closing prices of the underlying reference bond.

Note that CFD bond trading does not involve the physical delivery of bonds. However, you will receive potential profit from CFD bonds' differences in price movements over time.

How do CFD bonds work?

Bond issuers, such as governments, corporations, and institutions, offer bonds or debt obligations to public debt markets to fund their projects and meet their liabilities.

Once the bond issuers release the bonds to the general public, they must repay traders the face value, interest rate, and a fixed or variable dividend when the bonds mature.

However, CFD bonds are generally traded based on future interest rate expectations. You may take advantage of the bond price, market volatility, coupon payments, bond yield, and potential credit upgrades.

As mentioned, each CFD bond uses a specific bond as a reference asset. Without actually owning a CFD bond, you may reap a potential profit by speculating on the price movement of its reference asset.

In addition, bond yields and prices are inversely related. This means high-yield bonds correspond to low bond prices, while low bond yields indicate high bond prices.

In addition, CFD bonds rely heavily on economic factors. When trading bonds, you must carefully monitor interest rates and other market factors to make informed decisions and maximise potential returns.

You can trade CFD bonds through secondary markets via CFD trading platforms.

8 reasons to trade in CFD bonds

CFD bonds have various benefits compared to trading in the actual bond market. Here are the reasons why you should include CFD bonds in your trading portfolio:

1. Diversified portfolio: CFD bonds enable you to diversify your trading portfolios by gaining exposure to the bond market without the need to purchase or own the actual bonds.
2. Leverage: CFDs allow you to control a more significant position with less capital. CFD bonds may potentially magnify your profits (as well as losses) from small price movements.
3. Short-selling: You can take advantage of falling bond prices by immediately selling CFD bonds. Short-selling of CFD bonds can be done quickly as you don't own an actual bond.
4. Flexible trading: The CFD market is flexible beyond traditional market hours. CFD bonds are often traded 24/5 online. This allows you to enter and exit bond trading conveniently.
5. Lower barrier to entry and no ownership costs: CFD bond traders don't have to worry about storage, custody, or administrative costs associated with physical bond ownership.
6. Access to markets: CFD trading platforms like markets.com provide access to a wide range of bond markets and instruments globally.
7. No maturity constraints: Some actual bonds have a holding period return. In CFD bond trading, you can exit your position before maturity. This allows you to make a potential profit quickly.
8. Immediate trading execution: CFD trades can be executed quickly. This will enable you to trade bonds and gain exposure to market movements while reducing the risk of price slippage.

What are the risks, though?

Whether CFD bonds trading is favourable to you or not depends on your understanding of how CFD trading works and your risk tolerance.

Here are some risks that you should anticipate when trading CFD bonds:

CFD bonds are leveraged instruments

You can magnify your potential gains with financial leverage, which allows you to access the CFD bond market by putting down only a portion of the total value of the trade you want to make. This means you can make greater potential profits if the market moves in your favour.

Likewise, CFD bonds carry a high risk of substantial losses if the trade moves unfavourably. This is why you need proper risk management strategies when trading CFD bonds.

Dealing with market gaps and fluctuations

Gapping is a risk that occurs due to market volatility. This can prevent you from executing market orders or placing orders at specific skipped price levels due to the gap.

Market fluctuations can cause CFD bond prices to change rapidly and unpredictably. Several factors contribute to this volatility, including changes in interest rates, market sentiments, and economic indicators.

This results in orders being executed at prices significantly different from what you expect, leading to unexpected gains or losses.

Margin calls

When trading CFD bonds, you need to be prepared that a margin call may happen when you open a position. Here’s how it may occur.

First, you must pay an initial margin to trade CFD bonds. Your position will be marked to market every day. If the underlying asset's price moves unfavourably, you will be called for a variation margin.

You need sufficient cash in your account to cover this margin. If you do not have enough funds, your broker may choose to close your position.

Related: What is CFD trading? (A full guide with benefits, risks and CFD trading examples)

What determines the price of CFD bonds?

It is necessary to understand the factors that affect CFD bond prices when trading them in order to anticipate their future movements. CFD bond prices are primarily driven by interest rates, market sentiment, and economic indicators.

Interest rates hold as one of the key price movers of CFD bonds. An increase in interest rates makes people unsure about the potential gain they'll get from particular CFD bonds.

Traders may wonder if choosing a CFD bond is still a good idea when new CFD bonds are available with better interest rates. This may cause fewer people to trade a particular CFD bond. Eventually, specific CFD bond issuers may lower their prices.

Market sentiments, or shifts in traders' perceptions that can swiftly lead to price adjustments, are another factor. These occur for a variety of reasons.

The shift in behaviour might be due to specific strategies that traders use. For example, day trading may cause sudden changes in supply and demand, and eventually affect the price of a particular CFD bond.

Economic indicators may also affect CFD bond prices in response to broader economic conditions. For example, the cost of CFD bonds may increase due to Gross Domestic Product (GDP) growth.

A GDP that experiences growth signifies an increase in economic wealth. This GDP growth may result in a rise in corporate earnings and improved financial performance for the issuers of CFD bonds.

Trade CFD bonds with markets.com today

As you can see, CFD bonds have various benefits that give you a compelling reason to trade. However, its level of risk may not be appropriate for beginner traders.

At markets.com, we recommend understanding the risks, learning CFD trading, and seeking professional advice before deciding whether to start CFD bond trading. Our Education Centre offers many resources to help you learn about CFD trading.

You can trade CFD bonds on markets.com, one of the most trusted CFD trading platforms. This award-winning trading platform offers a wide selection of the most popular CFD bonds worldwide.

Ready to join our community? Start to practice trading with virtual funds now.

When considering "CFD bonds" for trading and price predictions, remember that trading CFDs involve a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.