What is CFD Trading?

A Contract for Difference is often abbreviated to a CFD and is a popular form of trading on the financial markets. A CFD is a contract or agreement which exists between a trader, who is the client, and the CFD company or broker. The agreement is to exchange the difference between the share’s price when the trade opens to it’s price when the trade comes to a close. The result will either be a loss or a profit for the investor. A CFD is traded on a margin and, like Spread Beating, a profit is able to be made not only when the market is rising but even when it is falling too as the trader actually has no ownership of the shares. In CFD trading, the investor never owns the instrument or asset that they are trading, as it is a derivative product with a value that is based on the underlying asset. CFD trading is a popular financial tool with a range of investors who appreciate the opportunity to purchase the rights to sell or buy a contracted number of shares in their chosen stock at a given price and for a set amount of time.

What is Trading on a Margin?

cfdsA trader will provide their CFD company with an amount as a deposit rather than funding the whole cost of all of their shares and this is described as a margin. The allows the investor to have access to a greater number of shares than would otherwise be available to them should they trade on the live market. The concept of trading on a margin is based on the trader only paying a percentage of the given share price. The CFD company will advertise their rate and therefore the trader will only need to front a smaller sum of money to begin with than if they were choosing to trade live on the share market. Often as small an amount as 5% of the overall share price is needed to be put down as an initial payment on the agreement. When trading CFDs, the investor is not required to actually purchase the underlying asset so they are able to hold a greater position that would otherwise have been possible when making a standard investment. CFD online trading has no set expiry date and therefore the trade can be closed whenever the investor believes the time is right to take their profit or alternatively to limit their loss should they start to lose money on the trade.

Best and Most Trusted Forex Brokers in 2018

Broker Min Deposit Welcome Bonus Rating
videforex logo $ 250 100% ★★★★

raceoption logo $ 250 100% ★★★★


See a List of Other Forex Brokers and Sites*Min. Deposit not applicable for EU brokers

How Does CFD Trading Work?

When trading CFDs, the investor is able to potentially make a profit whether the market moves down or up. If a trader believes that the price of the asset will rise they can “go long” (a term for opening a buy position). On the other hand, if they believe that the price of the asset will fall, they can “go short”, which is the term used for opening a sell position. The way the market performs will affect whether the trader will make a loss or a profit, and will also determine how much loss or profit will be made.

For example, if an investor thinks that their chosen market is likely to rise they may purchase a CFD for trading. The more the market rises, the greater the profit will be, however the more the market declines, the losses will also be greater. That rule is also applicable if the investor backs the market to fall – they will make a greater profit the more the market prices drop, but they will make a greater loss should the market rise further. The investor should also bear in mind however that CFDs are leveraged and therefore can result in a loss that actually exceeds the initial deposit.

Sell and Buy Prices

buy sell
The CFD company quotes a two way price on the market in the same way as would be seen in the underlying asset market. This will comprise the bid price and the offer price with the difference between these figures being called the spread. Should the investor think that the market will rise they will buy at the higher offer price whereas if they believe it is likely to fall, they will sell at the lower bid price.

Expiry Periods

In CFD trading there is no natural expiry period. Should the investor which to close out their position they can simply place an equal value trade in the opposing direction. For example, should an trader purchase 100 shares but then the asset price begins falling they may then decide to close their position to limit their losses. In order to do this, they simply sell 100 of the same shares and accept any losses made. Some CFD companies do offer exceptions to this rule however such as forward contracts which have a specified expiry date at some future point. Even with these kinds of contracts there is still no need for the investor to wait until the end of the expiry period before being released from their contract as they may simply trade out at any point before the end of the expiry date.

Which Markets Can be Used for CFD Online Trading?

There are many markets on which CFDs can be traded. These markets include:

Although these are the markets that are most popular for CFD online trading, there are many more including trading on the outcome of certain financial data releases and political events as well as Exchange Traded Funds and ETCs.

What are the Risks of CFD Trading?

Trading any financial market has an element of risk and CFD trading is no different. The primary risk of trading CFDs is market risk i.e. if the market makes a move against the investor, their position’s value will decline. However this is the risk that any trader takes when they participate in any traditional form of trading. An added risk comes from the fact that a CFD is a leveraged product, which increases the chance of incurring large losses significantly. As CFDs are traded on a margin, the investor is able to access the entire contract value for just a small percentage of the cost, however when they make a loss or a profit, these are based on the entire contract value and not only the amount that has been paid in the initial margin. The result of this is that trading CFDs may result in a loss that far exceeds the initial deposit amount. CFD trading therefore requires the investor to have a sensible and responsible approach to risk management.

What are the Advantages of CFD Trading?

There are numerous advantages to choosing to trade CFDs online. Here are some of the most popular reasons for opting to participate in CFD trading:

Are There any Disadvantages to Trading CFDs?

While there are numerous benefits for traders in choosing to participate in CFD trading, there are some drawbacks too. Here are some of the disadvantages of CFD online trading:

Top rated Forex bonus offers

$30 Free

Awesome $30 no deposit bonus to try XM services without risking your own money!

Get The Bonus

$20 Free

XTrade Europe Ltd offers $20 no deposit bonus. Can you make them into thousands of dollars?

Get The Bonus

*Not valid for EU traders, T&C apply

Up to $5000

Enormous $5000 deposit bonus, that will help you to reach the stars!

Get The Bonus

Up to $10,000*

One of the most attractive bonus packages from Plus500! Go get it now! *T&Cs apply.

Get The Bonus

Was the information useful?
CFD Trading
4.5 (90%) 2 votes