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CFD Trading  Explained

CFDs are derivatives that allow you to trade a wide range of products. CFDs are leveraged assets, a feature that makes them riskier. 

CFD Trading Explained
What is a CFD?

CFD stands for contract for difference. These assets are derivative products used to speculate on price movements.

Trading CFDs allows investors to gamble on whether asset prices will go up or down without buying the actual asset. Sounds complicated? No worries - we'll explain everything in detail.

Let’s say you want to profit from Microsoft's stock price going up. If you have an account at an online stockbroker, you can go ahead and buy Microsoft stock. If, however, you go for a CFD trade at a CFD broker, you will not buy the actual stock, instead you will buy a bet that the share price will go up. Naturally, you can also bet that the pice will go down. You sign a contract with your broker, which stipulates that the buyer and the seller must exchange the difference in the value of the Microsoft stock  between the time the contract starts and closes. You can then sit back and keep your fingers crossed that the price will go your way. 

All in all, trading CFDs is like using a sharp knife: it can be a useful tool, but you can cut yourself badly if you have no idea how to use it. 

What is leverage?

Many investors use leverage when trading CFDs. But what exactly is leverage? In the simplest terms, leverage is borrowed funds used for investment purposes. In our case, you will borrow funds from your broker to buy more Microsoft CFDs than you could with just your own funds. Think about leverage as a multiplier for your gains/losses. Leverage lets you gain bigger exposure to the markets. Most CFD brokers will require at least some level of leverage. Leverage levels of as much as 400:1 are not unheard of; however, various regulators around the world imposed leverage limits for various types of assets. 

At certain brokers, clients can set  leverage levels themselves while other brokerages have fixed levels. Make sure you understand the risks involved in leverage and you don't go overboard. High leverage may drain your position faster due to increased exposure.

Advantages of trading CFDs:

  1. You can make bets on all kinds of products. If, for example, you want to trade Turkish stocks, you can do that with CFDs at most CFD brokers. Buying actual Turkish stocks is only possible at a limited number of stockbrokers. It is easier for a broker to provide access to CFDs than to have access to the Turkish stock exchange.
  2. The second advantage is leverage. The odds of your bet will be much larger than buying the actual stock. Leveraged CFD trades come with greater risk, so we recommend you fully understand leverage before you invest.
  3. With CFDs, you can easily open a short position, which a big plus.

To understand these advantages better, check out our CFD trading tips

Not owning the underlying asset exposes you to additional risks

One of the key features of CFDs is that you do not own the stock (or any other underlying asset). When you trade CFDs, this poses a different kind of risk, which you need to understand before you dive deeper into CFDs.

Example:

Let’s say Bob bought Siemens stock for €50,000 and Janet opened a long Siemens CFD position for the same amount. They both did their transactions with Busy Broker Co. Then Busy Broker Co. goes bust. Here's what happens.

  • Since Bob’s Siemens stock is in custody with his custody service provider, sooner or later he will be able to collect it.
  • On the other hand, Janet will be compensated only up to the investor protection scheme of the country where Busy Broker is registered. In the EU, this is up to €20,000, but some countries don't offer investor protection at all. 

 

CFD Trading Explained
How much money do you need to trade CFDs?

At some CFD brokers, you can open an account with just a couple of dollars so you can jump into CFD trading with as little as a few bucks. If you don't have any trading experience, we recommend you to try it with a demo account first.

A demo account is a great way to get familiar with the trading platform of your broker before you start investing real money. Usually, demo accounts provide access to the real trading platform so that you can test the features. You can open and close trades, but you are using virtual funds and not real money.  We encourage you to make a few CFD trades on a demo account, assess the risks and play around with the virtual leverage. 

The initial amount you need for CFD trading varies depending on the particular asset you want to trade: you will need more funds if you want to invest in oil and a lot less if you want to buy or sell a few penny stocks.

CFD Trading Explained
Are CFDs safe?

CFDs are leveraged products that come with higher risks.

  • When trading CFDs, your losses and your gains can multipy: if the price of oil drops 5% and you have a 10x CFD, you are going to lose 50% (of your capital).
  • CFDs are usually traded on the OTC (over the counter) market, which is less regulated than centralized exchanges. The risk is high so it’s crucial to make sure that the broker you work with is legit and safe. 

CFDs are recommended for more experienced traders.

CFD Trading Explained
Can you lose more than what you invest?

The question is legit and the answer is twofold. 

  1. You can lose more on a given trade than what you invested in that specific trade because you can use leverage (see above).
  2. As to whether you can lose more than what you deposited to your account, depends on your broker. Some brokers offer negative balance protection, which shields you from losing more than what you transferred to your account. This is a fairly new regulation introduced in mid 2018 and it applies to EU regulated brokers.

CFD Trading Explained
How does CFD trading work?

It works the same way as most transactions on financial markets. First, you need to choose a broker for retail investors at which you can trade CFDs.  After creating an account via a CFD trading app or on the provider's website, you'll be able to log in to the platform. You will naturally need to transfer funds to your account. 

On the platform, you will see the same tools and info as on a stock trading platform. The platform will show the CFD tickers, the closing price, the buy and sell price, etc. Select the particular CFD you want to trade and open a position. Buy a CFD (go long) if you expect the price of the underlying asset to rise or sell (go short) if you expect it to fall.

Here's an example: say you want to open a position in Apple. If you think the price of Apple stocks will climb, you buy an Apple CFD, it you expect the price to drop, you sell. 

When opening a CFD position, you will always see a buy price (bid) and a sell price (offer). The bid will always be higher than the current price of the underlying asset and the offer will always be lower. 

One more factor you need to decide is how many contracts you want to trade. Note that markets have their own minimum number of contracts.

Once you opened your position, keep an eye on where prices are headed and - depending on the underlying market movement - close the position by clicking on the appropriate button on the platform. 

CFD Trading Explained
What assets can you trade in CFDs?

The most common assets you can trade in the form of CFDs are stocks, stock indices and forex, but the list is much longer. There are brokers that provide cryptocurrency CFDs as well, mostly for coins with the biggest volumes (Bitcoin, Ethereum). 

CFD Trading Explained
What is the duration of a CFD?

There are two types of CFDs:

  1. With expiration
  2. Without expiration

The product description will tell you if there’s an expiry and the exact date when the contract will expire. Usually, you can find the product description either on the trading platform or on the broker's website. Look for an "information" or "detail" button.

CFD Trading Explained
Is CFD trading tax free?

The tax rules pertaining to CFDs are different in every country. In general, CFDs are taxed just like any other capital gain. Always check local tax regulations and consult with your accountant or a tax advisor to get the full picture. 

Beyond the basics of CFD trading - continue learning

CFD Trading Explained
How to choose a CFD broker?

Here are a few key aspects to consider:

  • Fees: One CFD broker may charge 10-15 times more for a typical CFD trade than another. It’s definitely worth checking their fees.
  • Products and markets: Want to trade Amazon or Bitcoin CFDs? They won't be available at each broker. Take a look at the product portfolio before opening an account.
  • Account opening: Some brokers require a minimum deposit, others don't. 
  • Deposit and withdrawal: Transferring money to your account can be 5 times slower or more expensive from one CFD broker to another. 
  • Web trading platform: A user-friendly and well-equipped trading platform can significantly increase your comfort.

Not sure which broker to choose? For a tailored recommendation, check out our broker finder tool. Just enter the name of your country to see relevant brokers. Want more details? Compare brokers with this in-depth comparison table.

Click  here for an updated list of the Best CFD brokers.

CFD Trading Explained
Bottom line

Here's a snapshot of CFDs and the most important facors to consider when trading these instruments. 

CFDs,  short for "contract for difference" are derivative products used to speculate on price movements without owning the underlying asset. Owning the real asset is often pricey or complex for retail investors.

CFDs cover most markets but are riskier as they include leverage, which means you are more exposed to market movements and thus your losses may be much larger.

CFDs are considered a risky investment as most of these trades take place on OTC markets, which can lead to counterparty risk if you do not choose a well-established broker for your trades.

Make sure you research the broker thoroughly and understand the risks associated with CFD trading. If you are unsure or have questions, feel free to reach out to us on [email protected]

Author of this article

Bence András Rózsa

Author of this article

Bence András Rózsa is an experienced broker analyst. Having an MSc in international economy and finance, he focuses on equities, cryptos and newcomer financial services. He also has 2+ years of experience within the brokerage industry specializing in stock- and CFD/forex brokers, crypto providers and robo-advisors.

Bence András Rózsa

Broker Analyst

Bence András Rózsa is an experienced broker analyst. Having an MSc in international economy and finance, he focuses on equities, cryptos and newcomer financial services. He also has 2+ years of experience within the brokerage industry specializing in stock- and CFD/forex brokers, crypto providers and robo-advisors.

Everything you find on BrokerChooser is based on reliable data and unbiased information. We combine our 10+ years finance experience with readers feedback. Read more about our methodology

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