What Is CFD Trading: Explained

Jan 2019
Top 2 CFD brokers
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77% of retail CFD accounts lose money
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66% of retail CFD accounts lose money
What Is CFD Trading: Explained

CFDs are derivatites, 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 bet on price movements

CFDs allow you to gamble on whether asset prices will go up or down, without buying the stock.

Let’s say you want to profit from Microsoft's stock price going up. At an online stockbroker, you would buy the Microsoft stock. At a CFD broker, you can instead bet directly on the stock price going up. However, CFDs are much like knives: they could be very useful, but you can cut yourself if you have no idea how to use them. 

CFDs are an easy way to reach a lot of markets with leverage

Advantages of CFD trading:

  1. You can make bets on all kinds of products. E.g. if you wanted to trade with Turkish stocks, go ahead. This might not be possible with an online stockbroker. It is easier for a broker to provide a CFD than 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. It also comes with greater risk, therefore we recommend you to fully understand leverage before you invest.
  3. Lastly, with CFDs, 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). This poses a different kind of risk which you need to understand before trading CFDs.

Example

Let’s say Bob has a Siemens stock and Janet is in a long Siemens CFD 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.

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.

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.

What is CFD Trading
Are CFDs safe?

CFDs are leveraged products which 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. This risk is crucial so it’s of utmost priority for you to make sure the broker you work with is safe. 

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

This question is two fold.

  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 a 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 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 expirity 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 as any other capital gain type of income. Always check local tax regimen, consult with your accountant or a tax advisor.

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