Trading in Contract for Differences (CFD) is a type of derivatives trading, where you can make a profit or loss on the price movement of the underlying. The difference in the settlement between the open and closing trades are cash-settled. There is never any delivery of physical goods or securities in CFD trading.
In essence, when you use CFD:s to speculated you are making a bet on the price of the underlying – will it rise or will it fall? The CFD is a tradable contract between you and your counterpart.
CFD:s are only traded over-the-counter (OTC); they are not listed on exchanges such as NYSE, NASDAQ, LSE, etc.
Why is CFD trading popular?
Through CFD trading, you can gain exposure to things such as shares, stock options, commodities, ETF:s, and more, without having to actually buy and own them. Is it a very easy and convenient way of speculating, and taking a short position is just as simple as taking a long one.
Retail CFD trading
There are many trading sites available online where a person can carry out CFD trading. Even with a small bankroll, it is possible to sign-up, make a deposit and get started. This has made CFD trading a popular hobby in the 21st century.
Important: CFD trading, or retail CFD trading, is illegal in certain jurisdictions. Always check applicable laws in advance.
You wish to gain exposure to an ETF called XYZ, but without actually buying XYZ shares. So, you go to the trading site and buy a CFD on the XYZ. The CFD is for 100 shares in XYZ for $200 per share; the total position is $20,000.
After three months, XYZ is trading at $275 per share. You decide to exit your position and realize the profit: $75 per share. $75 x 100 shares = $7,500.
A CFD is always cash-settled, so your initial $20,000 position and the closing position of $27,500 is netted out. The trading site will simply put your $7,500 profit in your CFD trading account.
Since there is never any delivery of physical goods or securities in CFD trading, the underlying of a CFD can be almost anything with a fluctuating price/level. Shares, stock options, and similar securities are popular as underlying, but the underlying can just as well be something more elusive, like a stock index.
Many trading sites that offer CFD trading also offers leverage CFD trading. Using leverage is the same thing as borrowing money and using the borrowed money for speculation. If you have $100 in your trading account and use leverage to make a $1,000 trade, you have borrowed $900. If you lose everything, you now owe the trading site $900 and are obligated to pay it back by making a new deposit.
Never risk money that you can’t afford to lose!
Trading CFDs carries a high level of risk because they are leveraged financial instruments, which means that traders can potentially lose more money than they have invested. This is because CFDs allow traders to amplify their returns by borrowing money from the broker to trade a larger position. However, this also means that losses can be magnified as well.
In addition to the risks inherent in CFD trading, there are also risks associated with the underlying assets being traded. For example, if the price of the underlying asset moves against the position of the trader, the trader could incur significant losses. It is essential for traders to consider these risks carefully and to have a solid understanding of the market and the asset being traded before entering into any CFD trades.
There are a number of factors to consider when looking for a CFD broker. Some things to consider include:
- Regulation: It is important to choose a broker that is regulated by a reputable financial authority, such as the Financial Conduct Authority (FCA) in the UK or the Securities and Exchange Commission (SEC) in the US. This helps to ensure that the broker is operating in a transparent and honest manner.
- Fees: Different brokers charge different fees for their services, including spreads (the difference between the buy and sell price of an asset), commissions, and overnight financing charges. Make sure to compare the fees of different brokers to find the best deal.
- Product offering: CFDs are available on a wide variety of underlying assets, including currencies, commodities, indices, and individual stocks. Make sure to choose a broker that offers the assets that you are interested in trading.
- Trading platform: Most brokers offer their own proprietary trading platform or allow traders to use a third-party platform like MetaTrader. Make sure to try out the platform before committing to a broker to ensure that it is user-friendly and has all the features you need.
- Customer service: It is important to choose a broker that offers good customer service, as you may need help or support at some point during your trading journey. Look for brokers that offer multiple channels of communication, such as email, phone, and live chat.
It may also be helpful to read online reviews and ask for recommendations from other traders before choosing a broker.