What is CFD trading?
CFD trading is a way to speculate on financial assets, like stock trading or ETF investing. However, CFD trading is a bit different – unlike investing in funds or stocks, you never own the underlying market.
Instead, buy or sell a contract for difference (or CFD for short).
CFDs reflect the live prices of the financial markets. Trading one gives you the same exposure as if you had bought the asset it tracks.
But instead of investing in the market, you buy a contract. And this contract allows you to exchange the difference in the price of an asset from when you open your position to when you close it.
Let’s look at a quick example to see how this works in practice.
Example CFD trading: Tesla
Tesla is trading at $750 and you want to take your position on it. You could invest in Tesla shares with share trading or buy Tesla CFDs.
Invest
You invest in Tesla by buying 100 shares at $750. Tesla goes to $800 and you sell your shares. You sell each share for $50 more than you paid for it, giving you a profit of $5000.
CFD trading
You trade Tesla by buying 100 CFDs at $750 and then closing your position at $800. You exchange Tesla’s price difference with your provider and earn $50 for each CFD or $5000.
As you can see, the result from each position was the same, but the method of getting there was a little different.
If Tesla stock had fallen to $700, then the result would be the same again.
With one investment, you would sell your shares for $50 less than you paid for them. With CFD trading, you would still be trading Tesla’s price difference – but because the market has moved against you, you’re paying your provider $50 a share.
Why trade CFDs?
At this point you may be wondering why traders choose not to own financial markets when opening positions. The answer is that CFDs offer some additional features and flexibility that you would find hard to find when investing.
Let’s take a look at three main characteristics of CFDs.
1. Go short
As we have seen, a CFD is just a contract where your provider agrees to pay you the amount by which a market has moved in your favour.
Because you are not taking ownership of the market, you can choose to profit from upside moves (known as going long) or downside moves (known as shorting) when you open your position.
- you are long gone purchase CFDs. This earns a profit if the market is up when you close your position
- You’re passing by sale CFDs. Here you profit if the market is down when you close your position
Suppose you believe that the price of oil will fall soon due to the weakness in the global economy. With contracts for difference, you could take advantage of the bear market by selling Brent Crude Oil CFDs.
If the price of Brent crude falls, you can close your position and pocket the difference in price. However, if the price of oil went up instead, you would make a loss.
2nd margin
When you open a CFD position, you do not have to pay its total value. Instead, you deposit a deposit that can be 5% or 10% of the cost of the item. After all, you’re not actually buying the underlying asset, you’re just speculating on its price movements.
This is called leveraged tradingand the deposit you need to pay will be referred to as yours edge.
Leverage gives you more flexibility in distributing your capital. If you wanted to trade £50,000 worth of Rio Tinto CFDs, you might only need to deposit £10,000, which means you don’t have to tie up all your available funds in a single position.
However, your win and loss would both be based on the full £50,000. So while leverage can be a powerful tool, you should trade carefully and keep your risk management in mind.
3. Choice of markets
But there’s another advantage to never owning the assets you trade – you’re not limited to what you can buy or sell. If it’s a financial market with a price, you can probably go long or short with a CFD.
For example, FOREX.com gives you access to over 300 global assets. This includes 220 stocks, 15 indices, 80 forex pairs, precious metals and more.
Not only does this give you choice, it can also be useful for diversify your exposure. By trading markets across asset classes and geographies, you can lower your overall risk.
How to trade CFDs?
You trade CFDs in a similar way to buying other financial markets, such as B. Stocks. You buy or sell a set amount of your chosen asset, and how much you buy or sell determines your profit or loss.
The main difference is what you trade. Instead of stocks, currencies or commodities, you buy and sell contracts that mimic live prices of stocks, currencies and commodities.
For example, a Coca-Cola CFD will always track the price movements of Coca-Cola shares. Buying a Coca-Cola CFD is equivalent to buying a single share of Coca-Cola. You earn $1 for every dollar that moves up and lose $1 for every dollar that it moves down.
Buy 100 Coca-Cola CFDs and you make or lose $100 for every point the stock moves.
buying and selling prices
There are always two prices displayed in a CFD market. The first is the selling price, the second is the buying price. The difference between the two is called the spread.
Often you will find that all costs of trading a CFD are included in the spread, so you do not have to pay any commission. However, in some markets you pay via commission instead. You will find that the spread is much smaller in these markets.
For long positions, you open at the buy price and close at the sell price. With short positions, you start by selling CFDs and close by buying them.
Start CFD trading today
If you are new to CFD trading, you might want to start with a demo account. CFD demos allow you to test virtual currency trading markets and improve your skills before committing real capital.
You can open a free FOREX.com demo in seconds.
CFD trading tips for beginners
1. Stick to what you know
You can choose from an enormous number of CFD markets to trade, but that doesn’t mean you have to jump into obscure assets right away.
When starting out, it’s usually better to pick a small number of markets that you’re already familiar with. Once you start gaining confidence, you can try to diversify a bit more.
2. Start small
Position size can be of great benefit when trading. Essentially, the idea is to only risk a small percentage of your total equity on each trade – maybe 1% or 2%.
By keeping your overall spending low, you can learn from your mistakes without losing too much. If you only risk 2% on each trade, you can afford to lose 50 trades in a row before losing your bankroll.
3. Always use a stop
Stops (stop-loss orders) help you control your risk on a given trade by automatically closing a position when it reaches a certain loss level. They take some of the emotion out of trading and mean you don’t have to constantly monitor every open position.
Successful traders will not open a position without placing a stop – no matter how experienced they are. However, standard stops do not absolutely limit your risk as they can suffer from slippage. You need one for that Hold guaranteed.
