What is CFD trading?
CFD trading allows you to enter into contractual agreements to speculate on the moving price of an underlying asset. By buying and selling these contracts using a reputable CFD broker, you can make a profit (or loss) based on the price difference between the value of the asset at the point that your contracts are opened and closed.
CFDs are available on a whole host of financial markets and are by no means restricted to shares. You can buy and sell contracts on the value of indices like the FTSE 100, foreign currency (forex) pairs like the GBP/USD, and commodities such as gold and silver.
Main Features of CFD Trading
There are a few things to know before starting trading CFD. CFD trading has its unique meaning, and is characterized by specific features that you should be well aware of. In order to understand what is CFD trading one needs to get familiar with the main features of it, which include:
Short and long trading
CFD trading is unique in that you can profit from speculating on an underlying asset to fall in value as well as rise. If you believe an underlying asset is likely to rise in value, you would seek to go ‘long’ (buy the asset). At the other end of the spectrum, you would go ‘short’ (sell the asset) if you believed its value was at risk of declining.
If you only have a modest trading bank, CFD trading allows you to utilise leverage to maximise profitable trading positions and secure greater exposure to the market than the size of your initial deposit. Let’s say for example that you wished to open a position worth ten shares of Facebook. A typical trade on the stock market would require you to commit the full value of the trade up front. With CFDs, most CFD brokers will offer leverage, meaning you will only need to stump up a small percentage of the value of the trade, e.g. 20-25%.
Note: Bear in mind that, although leverage gives you a chance to yield bigger profits from a smaller stake, you can always experience magnified losses in line with the full value of the position, instead of the 20-25% you put up initially.
CFD trading allows you to trade all kinds of financial assets ‘on margin’. The margin is the size of the deposit needed to open and maintain a trading position with leverage. The size of margin required is typically stated as a percentage by CFD brokers, e.g. 20-25% as stated in the paragraph above.
Risk-averse financial traders will utilise CFDs as a way of hedging trading positions and minimising losses in particularly volatile markets*. The flexibility of CFD trading allows you to have multiple long and short positions open at once. When utilised strategically, it is possible for CFD traders to trade multiple associated assets simultaneously, to guard against the risks during a market period that appears bearish, i.e. experiencing a downturn.
*Check if your chosen provider allows hedging
How Does CFD Trading Work?
Now that you are familiar with the concept of CFDs and the core features that make CFD trading such an attractive proposition, let’s delve deeper into the four main areas you need to master as a fledgling CFD trader:
First and foremost, you should familiarise yourself with the ‘spread’ offered by your CFD broker. The spread is the difference in price between the ‘buy’ (offer) and ‘sell’ (bid) prices available for a particular asset. Typically, the offer and bid prices will be a little bit higher than the value of the underlying asset in its actual market.
For CFD traders preferring to go long on assets, it’s important that the spread is not too big between the offer and bid price. If the spread is too large, it’s possible that the price can move in the right direction but fail to move beyond the bid price, resulting in you having to close for a loss despite correctly predicting the market move. The greater the liquidity there is in a market, the tighter the spread. If you prefer to trade more obscure markets and assets, you must be prepared to accept bigger bid-ask spreads.
When it comes to the size of a typical trading contract for an asset, the deal size usually mirrors those offered on the underlying asset on the open market. For instance, if you wished to open a long position on 100 shares of Microsoft, you would need to set a deal size of 100 CFD contracts for the company. As the size of standardised CFDs simulates those on the open market, it is easy to see why many people believe CFD trading to be a like-for-like form of conventional trading, compared with variants like options trading.
It’s also important to get your head around the duration of CFD trades. With options trading, the orders typically have a fixed expiry and will close themselves once that time window expires. When you open a CFD trade, the only way to close your long or short position is to submit a second order in the market in the opposite direction.
Let’s say you opened a long trade on Microsoft at £1,000. The price moves in your favour to £1,005. To take the £5 profit per contract, you must enter a short order at £1,005.
If you forget to close a long or short position, your entry will remain in the market forever. In the UK, if you leave a position open overnight, you will be charged an overnight fee to cover the cost of your broker managing your leveraged position.
If you are wondering how to accurately calculate the profit or loss generated by trading CFDs, the equation you need to keep in mind is:
(Number of CFD contracts x Value per contract) x (Closing price – opening price)
Sticking with the example of a £1,000 long trade on Microsoft. If you had a deal size of 20 Microsoft CFD contracts at a price of £1,000 per contract, the calculation would be the following:
(20 x £1,000) x (£1,005– £1,000)
£20,000 x 5 = £100,000 profit
On the flip side, had your trade on Microsoft gone the other way and fallen to £995, the following loss would be incurred:
(20 x £1,000) x (£995 – £1,000)
£20,000 x -5 = £100,000 loss
Why Trade CFDs?
CFD Trading comes with many benefits when compared to conventional trading as we know it. Amongst these benefits, you’ve got a wider choice of financial assets to trade, accompanied by an equally diversified choice of top-notch and user-friendly trading platforms. But that’s not all. Advantage of CFD Trading include:
1. Greater leverage than conventional trading
Leverage in CFDs is available from 2:1 (50%) leverage up to a maximum of 30:1 (97%) leverage, giving you a chance to maximise profits from CFD trades from the smallest possible capital.
2. No restrictions on shorting assets
Some traditional trading markets restrict shorting on ethical grounds, but CFDs can be shorted whenever you like, giving you a chance to speculate from bad news as well as good. This is because a CFD trader never physically owns the underlying asset.
3. Access to professional trading platforms and order types
Most CFD brokers provide first-class trading platforms for CFD traders. These platforms will enable traders to enter the same order types as conventional stock brokers e.g. stop-loss and take-profit orders. The software also provides an extensive range of graphs, charts, and news reports/press releases to keep traders fully informed of technical and fundamental factors.
4. Diverse range of financial assets available to trade
There is an ever-growing spectrum of financial assets that CFD brokers are making available to trade. It’s no longer exclusive to stocks or commodities; you can trade contracts on forex, indices, and even fledgeling cryptocurrencies.
Best CFD Trading Platforms
Looking for the most reputable CFD trading brokers that offer the tightest spreads? Especially for a beginner it is hard to know which are considered as the best CFD trading platforms. Read on as we compare three of the most popular CFD brokers for newcomers to buying and selling CFDs in Europe:
- Available CFDs – AvaTrade clients have access to more than 200 individual CFD assets, such as forex pairs, commodities, cryptocurrency, and company stocks.
- Leverage – Maximum leverage of 30:1 is offered on select forex pairs.
- Trading platforms – AvaTrade offers integration with both MetaTrader 4 and MetaTrader 5 trading platforms.
- Demo account – Yes, a demo account is available to trade with play money to better understand the system and the markets.
- Minimum deposit – Minimum deposits of €100 are required, with minimum trades starting from €1.
- FCA Regulated? At the time of writing, AvaTrade is not regulated by the FCA. It is, however, regulated in Ireland by the Central Bank of Ireland.
- Available CFDs – Plus500 gives traders access to thousands of share CFDs, as well as a host of CFDs on forex, cryptocurrencies, commodities, ETFs, options and indices.
- Leverage – Maximum retail leverage available is 30:1 across most markets.
- Trading platforms – At the time of writing, Plus500 is not compatible with either MetaTrader 4 or MetaTrader 5. It operates its own proprietary trading platform for clients.
- Demo account – Newcomers to CFD trading can also obtain a demo account before signing up for a real-money account.
- Minimum deposit – Plus500 allows clients to deposit as little as £100 to start trading their CFD markets.
- FCA Regulated? Yes, Plus500 is fully regulated and licensed to operate by the FCA.
- Available CFDs – eToro offers even more share CFDs than Plus500, but not quite as many markets on the forex or indices front. eToro is a specialist in cryptocurrency CFDs however, with dozens of altcoins covered as well as Bitcoin.
- Leverage -The maximum available leverage offered to retail traders is 30:1.
- Trading platforms – eToro, like Plus500, operates its own proprietary trading platform, and is therefore incompatible with MetaTrader 4 and MetaTrader 5.
- Demo account – Demo accounts are available to give clients a taste of what social trading is really like.
- Minimum deposit – First-time deposits into eToro must be an equivalent of US$200 or greater.
- FCA Regulated? – Yes, eToro is fully regulated and licensed by the FCA, as well as the Cyprus Securities and Exchange Commission (CySEC).
It’s almost impossible to ‘crack’ CFD trading overnight. The best way to develop your trading skills and become a successful CFD trader that is profitable over the long-term is to get experience in the markets and understand how they move. A low-risk way to get CFD trading experience is to register for a demo account with your preferred CFD broker.
Most CFD trading brokers will allow newcomers to CFDs to create demo accounts for a predetermined period. Within these demo accounts, you will be able to execute trades in the market using play money instead of real money. It’s a chance to help you get to grips with the dynamics of markets you are interested in. A demo account will also familiarise you with the types of orders you can place in the market, e.g. stop-loss and take-profit orders, that can improve your risk management per trade.
Best CFDs Trading Apps
Looking to execute and manage CFD trades on the go? It’s easier than ever to monitor open positions on any kind of CFD thanks to the following mobile CFD trading apps. We’ve selected them for their compatibility with the majority of smartphone and tablet devices, their tools and the variety of CFD and other financial instruments available for trading.
- Compatible devices: iOS and Android
- Available CFDs: AvaTradeGO gives traders access to over 250 CFD instruments, including major forex pairs, stocks, indices, and more.
- Main features: The app’s exclusive technology makes it easy to monitor markets in real-time, as well as social trends among AvaTrade’s community of CFD traders.
- Compatible devices: iOS and Android
- Available CFDs: The Plus500 app allows you to trade leveraged CFDs on everything from stocks, forex, and indices, through to ETFs, options, and cryptocurrencies on your smartphone or tablet.
- Main features: The app contains a free unlimited demo account, with the chance to practice your CFD trading strategies using demo money. It also offers 24/7 customer support and multi-language functionality.
Compatible devices: iOS and Android
Available CFDs: eToro members can trade over 2,000 CFD instruments using the mobile app, across numerous classes including stocks, indices, cryptos, and more.
Main features: Trade CFD stocks and pay zero commission on all trades via the eToro app. The app also allows you to monitor social activity on the eToro community to keep up with trends and real-time analysis.
CFDs Trading Risks
Whilst it’s important to be positive and look to the many benefits that trading CFDs can bring to your investment portfolio, it would be negligent not to consider the potential risks to your capital too:
- Choosing an unregulated, irresponsible CFD broker – too many newcomers to CFD trading still get their fingers burnt by depositing funds with unregulated brokers. Before you part with your hard-earned cash, be sure to do your research on the background of your preferred broker – or check out our latest independent broker reviews.
- Unexpected shifts in market conditions – even the best CFD traders can encounter unforeseen fluctuations in the market. Given its real-time nature, political and economic developments can quickly lead to negative effects on the value of underlying assets and your subsequent contracts.
- Illiquid contracts – In more obscure markets where fewer traders are being executed, it’s possible for open contracts to become illiquid; with brokers charging extra margin payments or even closing contracts at vastly inferior prices.
Why Trust Us
At FXForex.com, we consider ourselves the go-to resource for anyone new to CFD trading. Our trading guides and impartial CFD broker reviews provide a direct approach to understanding the CFD markets and which broker or trading platform is best for you.
Now that you are familiar with the basics of CFD trading, be sure to check out our reviews of the leading CFD brokers to find a platform that meets your needs. Finding the best broker for CFD trading may not happen overnight, but it is definitely easier to start to look for one after reading our comprehensive guide.