How Do Shares CFDs Work? A Comprehensive Guide for Beginners

If you’re looking to get into trading shares, CFDs can be a relatively simple way for you to get started.

However, there are a number of key risks that come with CFDs, which is why it’s important to thoroughly understand how they work and what those risks are.

That’s what our beginner guide to shares CFDs is all about.

So, how do shares CFDs work?

When you trade shares in the traditional way, you own them. (You’re a shareholder.)

So, if you buy 10 Apple shares, you are an Apple shareholder. If your share price goes up and you sell your share, you profit from the difference in price.

With CFDs, though, you don’t own the shares. Instead, you’re simply speculating whether the share price will go up (or down).

You’re still hoping to profit from movements in the share price, but using CFDs is in some senses a more simple way of doing so.

CFD stands for ‘Contract for Difference’

In a CFD, you and the CFD broker agree to exchange the difference between the price of an asset when the contract opens, and the price of an asset when it closes.

You choose how many contracts you want to open at once, and this dictates the total size of your trade.

It’s fairly easily to calculate how much your share CFD trade is worth, because the price of one contract is the same as the price of one share of the company.

As you can see, it’s relatively simple to calculate your positions and potential return once you get the hang of it.  

However, there’s a bit more to most share CFD trades. The majority of them make use of leverage.

How share CFDs use leverage, and what you need to know

Leverage allows you to place larger trades than you might otherwise, by borrowing money from your CFD broker.

Calculating profit and loss on leveraged CFDs

It’s important to understand that when you use leverage on CFDs, your profit and losses are calculated on the size of the trade, NOT on the money you put in.

This means you can lose more money than you put into the trade.

Let’s look at our $50,000 example trade again.

Say that you make a 10% profit on this trade.

This would give you a total return of $55,000, and a profit of $5,000.

You only supplied $2,500 in actual money to place the trade, so although your profit on the trade is 10%, your actual monetary return is 100%. (You’ve doubled your money on the trade.)

However, this principle also applies to your losses. Had you lost 10% on the trade, your total loss would have been $5,000 – twice the money you put in.

It’s for this reason that many traders choose not to use leverage at all. They deem the risk of losing more than your initial capital to be too big.

Summing up

CFDs can be an effective way to trade shares, and can allow you to go long and short with relative ease. They also free you from any issues arising from being a shareholder.

However, CFDs are classed as a high-risk instrument, and the use of leverage means you should always do your research before you take on any risk.

And, as always, do not trade with money you can’t afford to lose.