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What Is CFD Trading: Explained

CFDs are derivatives, you can easily trade with a wide range of products, but it is leverged, so it is risky.

What is CFD Trading
What is CFD?

CFDs are derivatives: you speculate on price movements

What is CFD, and how does it work?

Trading CFDs will allow you to gamble on whether asset prices will go up or down, without buying the stock on the global markets. However, you do not actually own the underlying asset. No worries - we'll detail everything below about how trading CFDs work.

Let’s say you want to profit from Microsoft's stock price going up. At an online stockbroker, you would buy Microsoft stock. During a CFD trade at a CFD broker, you can instead speculate directly on the stock price going up or down. In such a situation, you don't actually own the underlying asset - you only get into a contract with your counterparty.

All in all, trading CFDs are much like knives: they could be very useful, but you can cut yourself if you have no idea how to use them. 

What is leverage?

Think about leverage as a multiplier for your gains/losses. Leverage lets you gain bigger exposure on the markets with a smaller capital. Most brokers require you at least some levels of leverage: a minimum of 5x or 10x (1:5, 1:10).

Some brokers have the option to select different leverage levels, some provide a fixed setting for any client. Be sure to know the risks here, as leverage may drain your position faster due to increased exposure.

CFDs are an easy way to reach a lot of markets

Advantages of trading CFDs:

  1. You can make bets on all kinds of products. E.g. if you wanted to trade with Turkish stocks, go ahead via the tools of CFD trading. This might not be possible with an online stockbroker. It is easier for a broker to provide a floor for CFD trading 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 with buying the actual stock. Such CFD trades also come with greater risk, therefore we recommend you fully understand leverage before you invest.
  3. Lastly, with CFD trades, you can easily have a short position. That is a plus indeed.

To understand these advantages better, you can learn through CFD trading tips

Not owning the underlying asset exposes you to additional risks

One of the first things you should know when you learn what is CFD trading is that you do not own the stock (or any other underlying asset). When you trade CFDs, this fact poses a different kind of risk which you need to understand before you dive deeper to trade CFDs.

Example:

Example: Let’s say Bob has a Siemens stock and Janet is in a long Siemens CFD trading position, both with broker “Bust Broker Co.”. Bust Broker Co. goes bust. In this case

  • Since Bob’s Siemens stock is in custody with his custody service provider, sooner or later he will be able to access it.
  • On the other hand Janet will be compensated only up to the investor protection scheme of the country. In most cases, this is up to €20,000.

As you see, virtually you are getting into an agreement via a contract with the broker, hence the name "Contract for Difference", which doesn't have the real underlying assets under the deal. Not owning the underlying assets is not necessarily a bad thing, but has downsides, as you'd be compensated to a certain level if the broker is under such a regulation.

What is CFD Trading
How much money do you need for it?

At some CFD brokers you can easily open an account even with just a couple of dollars so you can jump into CFD trading easily. If you don't have any trading experience then we recommend you to try it with a demo account first though.

A demo account is a great way to get familiar with the platform you'd like to use real funds on. Usually, such accounts provide an access to the real platform itself with the same, fluid dynamics as on a real platform. Opening and closing trades feels just the same, only you are using virtual funds and not real funds as a CFD investor would. In this sense, you can try CFD risks out, as these demo accounts provide virtual leverage as well and real price differences (or market risk). Through a virtual space, you can initiate a trading experience on regulated exchanges, just like with a real account.

The money you need for CFD trading varies by asset classes. Some need more initial money, i.e. oil needs more than a penny stock, mostly it depends on the covered asset.

What is CFD Trading
Are CFDs safe?

CFDs are leveraged products that come with higher risks.

  • It can multiply both your losses and your gains e.g. the oil price drops 5% and you have a 10x CFD, you are going to lose 50% (of your capital).
  • The other risk is that it’s usually traded on OTC (over the counter) market which is less regulated therefore than centralized exchanges. Imagine this market as the broker's own CFD market. This risk is crucial so it’s of utmost priority for you to make sure the broker you work with is safe. 

This asset type is definitely recommended for more experienced traders.

What is CFD Trading
Can you lose more than what you invest?

This question is twofold.

  1. Whether you can lose on a given trade? You can lose more on a given trade than what you invested in that specific trade because you can use leverage (see above).
  2. Whether you can lose more than what you deposited to your account? EU regulated brokers offer negative balance protection which prevents you from losing more than what you funded your account with. This is a fairly new regulation since mid 2018 and it applies to EU regulated brokers.

What is CFD Trading
How does CFD trading work?

It works the same way as other financial markets. First, you'd need to choose a CFD provider for retail investors, at which you can trade CFD contracts, as CFD trading is available to retail investor accounts as well. 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.

On the platform, you'd see the same tools and info as on a stock trading platform. Such a CFD trader platform has the same features and tickers: shows the closing price, buy and sell price, the desired financial instrument, selling prices and so. CFD providers also let you have access to forex pairs if you'd like to trade them instead of CFDs.

What is CFD Trading
What assets can you trade in CFDs?

Mostly stock CFDs, or stock indices in CFD form. There are also brokers, who provide cryptocurrency CFDs as well, mostly for coins with the biggest volumes (Bitcoin, Ethereum)

What is CFD Trading
How long does a CFD last?

There are two types of CFDs:

  1. With expiration
  2. Without expiration

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

What is CFD Trading
Is CFD trading tax free?

It’s different in every country. In general, it’s taxed just like any other capital gain type of income. Always check the local tax regimen, consult with your accountant or a tax advisor to get to know how taxation works after a CFD trade.

Learn about a broker

Beyond What is CFD Trading - continue learning

What is CFD Trading
How to choose a CFD broker?

There are many aspects of a good broker (service provider). To find the perfect match, here are a few things to do some research on:

  • Fees: The overall cost of a typical CFD trade can be 10-15 times higher at one CFD broker than at another. So it’s worth checking their fees.
  • Products and markets: You want to trade with Amazon or Bitcoin CFDs? They might not be available. Check the product coverage before opening an account.
  • Account opening: Some brokers require a minimum deposit, while others don't. Check what the conditions are at the best CFD brokers.
  • Deposit and withdrawal: Transferring money to your account can be 5 times slower and 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 and you will see only the relevant brokers. Want more details? Compare brokers with this in-depth comparison table.

We also have an updated list of the Best CFD brokers here.

What is CFD Trading
Bottom line

In this article, we wanted to give you a short introduction to how CFD trading works and its aspects. Below we have summed up the most important info for you.

CFDs are derivatives, of their underlying assets. They are short for "Contract for Difference" and they are used to speculate on price movements without having to own the real asset. Owning the real asset is often pricey or complex for retail clients.

CFDs cover most markets but are riskier as they include leverage - which means you are more exposed to market movements and can lose more than you initially planned.

CFDs are considered a risky investment opportunity because of the need to use leverage, and because most of these trades happen on OTC markets which can lead to counterparty risk if you do not choose a well-established provider for your trades.

Make sure to do research on the provider you'd like to choose and the risks you can face when trading, or trading with CFDs. 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’s purpose is to help you to understand the logic behind financial services. In his master’s studies, he specialised in business economy and finance to be able to give you a clear picture of the brokerage world. Having reviewed multiple brokers and robo-advisor services, his goal will always be to guide you in the world of investing as it is.

Bence András Rózsa

Broker Analyst

Bence’s purpose is to help you to understand the logic behind financial services. In his master’s studies, he specialised in business economy and finance to be able to give you a clear picture of the brokerage world. Having reviewed multiple brokers and robo-advisor services, his goal will always be to guide you in the world of investing as it is.

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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