Did you know that you can trade the price movement of assets such as stocks, foreign currencies, and indices without having to physically own the underlying asset? Contracts for difference (CFD) trading gives retail traders access to a comprehensive range of financial markets, allowing you to speculate on whether a price moves up or down.
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.
There are a few things to know before diving right into CFD trading. This kind of online trading is very unique, and is characterized by specific features that you should be well aware of. The main features of CFD Trading include:
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
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
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:
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.
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.
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.
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.
Looking for the most reputable CFD trading brokers that offer the tightest spreads? Read on as we compare three of the most popular CFD brokers for newcomers to buying and selling CFDs in Europe:
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.
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: 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.
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:
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.
It’s important to bear in mind that profits from CFD trading are taxable income. Any profits during a financial year must be declared in your country's tax assessment.
Although nothing is ever certain with trading CFDs, traders have much more control over their market entries in comparison with gambling, which generates outcomes that are largely out of your hands. Although there are significant risks attached to CFD trading, it’s possible to utilise technical and fundamental analysis to research and execute trades, just like you would with real-world shares or securities.
The money you invest into trading CFDs is safe providing you choose a licensed and regulated broker. Those regulated and licensed under the Financial Conduct Authority (FCA) are lawfully required to protect your funds up to a maximum of £85,000.