Tuesday Apr 11 2023 08:28
35 min
3.1 Benefit 1 – CFDs make it simple to go long or short on your trade
3.2 Benefit 2 - CFDs allow you to trade a wide number of assets
3.3 Benefit 3 - CFDs allow you to access the market with less capital, by using leverage
3.4 CFD Benefit 4 – Diversification (again, due to leverage)
4. An Important Note. When trading CFDs, you do not own the underlying asset.
5.4 CFD Risk 3 – CFDs can move fast, potentially faster than you can react
5.5 CFD Risk 4 – Margin means you’ll need more capital than just your stake
6. What happens if the price of my asset falls quickly, and moves below the ‘margin’ in my account?
9. What are ‘lots’ in CFDs? (The difference between CFDs and spread-bets)
11. Where can I practise trading CFDs? Try the best CFD trading platform out there.
If you want to be able to make short and long market trades with simplicity and speed, then CFDs can be an effective way to meet your financial goals.
So, what is CFD trading?
CFD stands for Contract For Difference.
When you enter into a CFD, you and a broker agree to exchange the difference between an asset’s price when you open the trade and the asset’s price when you close the trade.
CFDs can be a powerful tool, but it’s important you understand them thoroughly before you start trading.
In this in-depth guide, we’ll answer a number of CFD FAQs, including:
We’re also going to show you how to practise trading both long and short CFDs without risking any real money. If you want to become a more knowledgeable, confident trader, keep reading.
A CFD is an agreement between you and a broker to exchange the difference in an asset’s value between:
The difference between the two values will be either your profit or your loss, depending on how you choose to enter the contract.
Let’s go through a step-by-step CFD trading example.
Had the price of a ‘lot’ of silver fallen to be worth $150, you would have lost $500.
You can choose to enter a contract for difference in two ways: as a buyer or as a seller.
Understanding this is quite simple:
If you believe the price will go up, you want to be the buyer. If you buy a stock for $200, and it increases in price to $250, you can sell it back and make $50 in profit.
If you believe the price will go down, you want to be the seller. If you sell a stock for $250, and it falls to $200, you can buy the stock back for less than you sold it for, and again the $50 is profit.
Though you don’t actually own the stocks when you trade CFDs, the principle is the same.
If you believe an asset is about to fall in value, as we’ve just covered, you may want to place a ‘short’ trade.
This means that if you’re correct and the asset falls in value, you will profit from the decline in price rather than losing money.
Unfortunately, short selling in the traditional investing sense can be quite complex. You will need to arrange borrowing the stock or asset you wish to short, and you’ll need to find a buyer. There are also multiple fees and charges to consider.
This can make short-selling intimidating, to say the least. (You can read our full guide on short selling here.)
When you trade CFDs, however, placing a short trade is no different in a technical sense than placing a ‘long’ position.
Here’s a snapshot we’ve taken from the markets.com trading platform:
Once you’ve inputted the number of units you’d like to trade in the central box, placing your trade is simply a matter of clicking:
You’ll then be taken through to the next screen, where you can add the specifics of the trade.
The ability to short or long on a trade with the same ease can be a major benefit for traders who regularly do both.
It’s possible to trade a wide range of market assets using CFDs, including:
*Crypto currency CFDs are prohibited in some countries, such as the UK.
markets.com alone has more than 3,000 instruments ready for you to trade on our CFD trading app.
Whatever trading strategy you want to follow, and however you want to diversify, you should be able to achieve your goals using CFDs.
Сalculate your hypothetical P/L (aggregated cost and charges) if you had opened a trade today.
Market
Instrument
Account Type
Direction
Quantity
Amount must be equal or higher than
Amount should be less than
Amount should be a multiple of the minimum lots increment
USD
EUR
GBP
CAD
AUD
CHF
ZAR
MXN
JPY
Value
Commission
Spread
Leverage
Conversion Fee
Required Margin
Overnight Swaps
Past performance is not a reliable indicator of future results.
All positions on instruments denominated in a currency that is different from your account currency, will be subject to a conversion fee at the position exit as well.
CFDs use leverage, which means that as a trader, you won’t require as much capital to place a trade as you might when placing a normal investment.
The amount of leverage you can access – and how much you choose to use – will depend on a number of factors, including:
By giving you the option to place trades with less initial capital, CFDs can help you diversify your trading positions.
We’ve talked here about placing ‘trades’ using CFDs. It’s important to understand, though, that trading CFDs is different to placing traditional trades.
When you place a CFD trade, you are not actually buying the underlying asset.
A CFD is what’s known as a ‘derivative’ financial product. As in, the value of the trade ‘derives’ from the price of the underlying asset.
So, opening a CFD on the price of 100 shares of Apple is not the same as actually buying those 100 shares. You don’t become an Apple shareholder.
The only contract is between you and the CFD broker.
(This means that you will not be entitled to shareholder benefits. Though in some cases dividend payments may be ‘factored in’ to the value of your CFD contract. For a detailed guide on the specifics of dividends within CFD contracts)
All trading carries risk. No investment of any kind is guaranteed to make you money.
If you’re not comfortable with the idea that some of your trades will lose money, you shouldn’t be trading at all.
As legendary trader Paul Tudor Jones once put it: “Trading is very competitive, and you have to be able to handle getting your butt kicked.”
All traders – even the very best ones – make the wrong calls and lose money sometimes. The key is to have a risk strategy in place that cuts losses quickly. Then, if you maximise profit from your good trades, you can become profitable over time.
And remember, not all losses are created equal.
If you place an unleveraged long trade, for instance, your losses are inherently limited because the most any asset price can fall is to zero.
Short trades, conversely, are essentially limitless. There’s no limit to how much the asset’s price can increase by. This means that if you trade against, it, your losses can be technically infinite.
Earlier, we talked about how you can use leverage to your benefit when trading.
Now, it’s time to talk about the flip side of the coin. The fact that while leverage can ‘amplify’ your gains, it can also amplify your losses.
You can in fact lose more than your initial capital if the markets move against you.
And remember, if this was a short trade, there would be no limit to your potential losses.
This level of risk is why many investors choose not to use leverage at all. They simply don’t believe the risk is worth the potential reward.
It’s entirely up to you whether you decide the same. It’s all down to your individual risk profile.
Here’s a short animation of a CFD trade on gold ‘in flux’:
As you can see, the gold price is constantly changing according to price action in the market.
If you monitor the price live, most of the time you’ll see it ‘ranging’. (This just means the price is constantly moving up and down within a specific ‘high’ and ‘low’.)
Here’s an example of Google stock in a ‘range’:
As you can see, it’s moving up and down in price within a fairly predictable pattern. When it hits the low point within the ‘range’, it rebounds back up, and vice versa.
The graph you can see represents just under 24 hours of trading.
Now, let’s add in the next 24 hours of trading:
As you can see, the fall in price is sudden. In this case, it’s a fall in the price of about 5% in a day.
Now, 5% might not sound like a huge fall. But let’s say you’d used 40:1 leverage to obtain a £20,000 position in Google stock.
You would have only used £500 in capital to make the trade.
But your 5% loss here would have been £1000. Double your initial stake. In less than a day in this particular case.
If you’re going to trade CFDs using leverage, you need to be aware how fast the markets can move. Trading prices can move quick. Even quicker than this example in some cases.
And it’s also worth noting that prices don't just move quickly, they can also move in a non-linear fashion.
For instance, if the price of a share falls from 20.10 down to 20.00, it won’t necessarily move 20.10 to 20.09 to 20.08 and so on. It can easily leap straight from 20.10 to 20.00 in a second or so.
Again, that might not sound like much, but when you’re using leverage even a 10-point fall could mean a big loss.
Please understand that we’re not trying to scare you here.
The fast movement we’ve described here is also possible on the upside. You could gain 10 points – and make a substantial profit – just as fast as the loss examples we’ve given here.
But it’s very important to understand the risks of trading before you start opening positions for real, and the fact are that CFDs can move very quickly in price either direction.
(That’s part of the reason markets.com have a demo account, so you can practise making, monitoring and closing CFD trades using demo funds. You don’t need to fund your account to use the demo account. So, if you are interested in becoming a trader and want to practise using the same ‘pro level’ platform our top traders use, sign up for an account today and download our CFD trading app.)
Margins aren’t necessarily a ‘risk’ as such, but you do need to be aware of them when trading CFDs.
So, we’ve included them here.
Here’s how margin works.
If you plan to use leverage, your broker will require you to add additional capital to your account above the cost of the trade itself.
Think of it as ‘collateral’, to prove to the broker that you aren’t making trades you can’t afford to make, and that you can cover yourself in the event of losses.
(15% margin in a trade of this size would be quite excessive, but it is a good way to understand why you need more than just trading capital to get started, even with CFD trading.)
Say your silver trade suffers serious, quick losses and the price falls by £400. Your losses are now bigger than the margin cost of £345.
This is what’s known as a ‘margin call’. (A phrase which lent its name to a 2011 movie starring Jeremy Irons and Zachary Quinto.)
If this happens, your broker will ask you to deposit more capital to ensure your margin returns to the level needed to ‘cover’ your trade.
See, there are actually two types of financial margin:
The example we just gave – the required margin to open a position – is known as the ‘initial’ margin.
However, all brokers will also ask you to keep what’s known as a ‘maintenance’ margin.
This is a specific percentage of the total value of your account’s open trades.
Yes, it’s possible to trade CFDs without leverage, and some traders do exactly that.
In financial terms, using an un-leveraged CFD isn’t massively different to placing a traditional trade. (Though you may miss out on shareholder benefits, such as dividend payments.)
So, why do it?
Usually, the answer is convenience.
Imagine you want to place a short trade on the price of crude oil. The value of the trade is £10,000, and you have that in capital, ready to invest.
You can either choose to go the traditional short-selling route, which will involve borrowing and lending from a number of different parties, not to mention additional costs and fees…
Or you can place a simple unleveraged CFD with a couple of clicks on your trading platform.
If you plan on placing multiple short trades, then as you can see, CFDs can make things a lot quicker and easier.
It’s all a matter of what your trading goals are. If you’re only planning to place one short trade every year, then you might decide to go with the more traditional approach.
You’ll encounter a number of charges when trading CFDs. Not all of these will apply to every trade, but you should take the time to be aware of them all:
Some brokers may take a small percentage of your capital as a fee when you’re making a deposit or when you’re withdrawing money. (markets.com does not do this.)
The ‘spread’ is the gap between the highest price a market will pay for any given asset, and the lowest price anyone holding the asset will sell at. This gap means that when you sell out of a position, the price displayed on your trading platform won’t be the exact price you sell for. The exact price will be somewhere in the ‘spread’.
Usually levied on share CFDs, commission means that the broker will take a small percentage of the full value of the trade as a payment. So, if you’ve taken a trade on Amazon stock worth £5,000, and the commission rate is 0.10%, your commission charge will be £5. (markets.com does not currently charge commission fees.)
These are small payments that are applied to your account if you hold a CFD trade overnight. These fees are pretty much universal within the CFD trading world. They can vary depending on if the trade is short or long, and on which asset you’re trading. Usually, a broker will list these fees on their website, so you can account for this kind of cost in advance.
Different assets are valued in different currencies. So, if you trade crude oil in the UK, the trade will still be valued in US dollars. This means that your initial stake must be transferred from dollars to pounds, and then any profits must be traded back. This costs CFD brokers, who will then usually cover their exchange costs will a small additional charge on your trade.
Depending on your tax jurisdiction, you may be charged capital gains tax on any profits made from CFD trading.
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Trading CFDs, you don’t measure the size of your trade in ‘points’ like you with spread-betting.
When you trade CFDs, the size of your trade will be measured in ‘lots’.
This is a unit of measurement that is unique to the asset you’re trading.
For instance:
When you trade a CFD, your position size is measured in how many ‘lots’ you wish to trade.
If your chosen asset is more expensive, a single lot may be too expensive for you to trade. (Or require more leverage than you’re comfortable with.)
In this case, you can choose to trade what’s known as a ‘micro-lot’. This means you trade less than the value of 1 lot.
So, in our Tesla example above, had you chosen to short at 0.5 per lot, the total value of your trade would have halved to £3,100, and your total profit would have been £800.
How small a fraction of a lot you can trade will depend on different factors, including:
Typically, it won’t be possible to trade any lower than 0.1. of any asset.
CFDs are legal in many countries around the world. markets.com is a regulated broker in the UK, Europe, South Africa and the ASIC region.
As long as you trade through a regulated broker, CFD trading is legal.
As with all trading, CFDs carry risk. The more leverage you use, as we explained in our earlier example, the more you can lose. It’s possible to lose more than the actual capital you place the trade with.
As with all trading, if you’re not comfortable with risking your capital, you shouldn’t trade. CFD positions can move fast, and you should monitor all positions carefully.
If you want to practise trading CFDs with no risk, then sign up for a markets.com account today, and download our CFD trading app.
We provide a full demo account, complete with artificial funds, so that you can get used to trading CFDs without losing any real money.
This gives you time to become a confident trader before you place any trades for real.
Then, if you do decide you want to step up to trading for real, you can fund your account properly, and get started.
You can click here if you’d like to open an account with us today.
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