CFD Trading Guide

Richard Montana | October 21, 2022

What is a CFD?

CFD means Contract For Difference which is a financial instrument that allows you to trade and try to benefit from the movement of price in various asset classes including Forex, Commodities, Cryptocurrency, Stocks, Indices and ETFs.

The introduction of CFDs made it possible for online traders to have access to a wide range of markets that were not previously available to them.

When trading CFDs, you do not actually purchase or own the underlying asset, you are speculating on the price movement, up or down. A CFD is a contract to between two parties to pay the difference between the value of the current price and future price

CFD is similar to forex trading in many aspects and are traded through an online brokers trading platform. You simply select the trading instrument that you wish to trade and place your orders. If you believe an instrument will increase in price, you would look to enter a buy (long) position. If you thought the instrument would decline in value then you would look to enter a sell (short) position. The profit or loss is realised depending on the difference between the entry and exit prices when you close the trade. CFDs can be bought or sold at any time that you deem suitable as they do not have an expiry date.

CFDs have become very popular in recent years, especially for day traders. The high leverage and low costs associated with trading CFDs online make them an attractive proposition to retail and institutional traders.

What is CFD trading?

CFD trading if considered by many to be more simplistic when compared to some other complex trading strategies. An individual can buy or sell a CFD depending on if they believe that the underlying asset will increase or decrease in price throughout the duration in which they hold the contract. The difference in the price of the CFD from the position entry and exit, is the trader’s profit or loss.

For example, if a trader thought that the price of the EURUSD currency pair would increase, they could place a buy trade. If the EURUSD price increased and they closed their position, the profit would be the difference in the price from when they entered trade, minus the spread and any broker commission fees. However, if the EURUSD fell in value and the trader closed the position, they would have made a loss.

CFD prices

When trading CFDs online, you will be presented with the buy price (bid) and sell price (ask). These prices are based on the underlying instruments that you are dealing with in the CFD contract.

The buy price will usually be higher than the sell price. The difference between these prices is known as the spread. The majority of CFD trades executed through a broker will be charged the spread, although this is not the case with all asset classes.

Some brokers include a commission fee in addition to the spread. There can also be other fees such as swap fees for holding trades overnight. It is important to be away of all brokerage fees when trading CFDs as they can have an impact on your trading strategies, especially if you are an active trader looking to place trades on a frequent basis.

CFD contracts

If you are trading CFDs, you will need to decide how many contracts it is that you wish to enter for each position. Each market and broker can have a minimum requirement, usually from one contract. On a standard account, one contract is around $10 per point. Some brokers will allow micro/mini contracts where you can trade from $1 or even $0.1 per point. This can give you more flexibility on your trades and allow you to control your risk exposure accordingly.

It is worth keeping in mind that CFDs can be leveraged which means that you can control a position size larger than your balance would have been able to without it. For example, an account of $5,000 with 1:30 leverage, could control a position size of $150,000 ($5,000 x 30 = $150,000).

Whilst this may seem appealing as a leveraged position can improve potential gains, it also significantly increases risk exposure and the potential loss. It is therefore imperative that anyone considering trading CFDs, has a full understanding of what leverage is and the risks involved with trading online.

Stops & limit orders

Traders can use a stop loss to help restrict the potential loss on a CFD trade. You place a stop loss at a price where you would want the position to be closed should it move against you by the specified amount. You can also manually close a CFD trade before the stop loss is reached.

Basic stop losses may be affected if there is a market gap which can occur during volatile market conditions or overnight. Some brokers offer guaranteed stop losses for a premium which will close a trade at your requested price level. There are also trailing stops that can lock in your position and follow price when the market moves in your favour.

Limit orders do the opposite to stop orders. You can place a limit order at a desired price to close a trade if the market moves in your direction. This can be a useful way to secure profits, especially in volatile markets. You may also choose to manually close a position in profit before the limit order is reached.

CFD trade example

An individual wants to trade CFDs on a stock that has an asking price of $35 and opens a CFD with a value of 100 shares.

Using the traditional method of trading shares, the cost would be $3,500 including any commission and other fees.

If they were using a CFD broker that had a leverage of 1:20, they would be able to enter the trade with an account size of $175. This is because $175 x 20 = $3,500.

This makes trading CFDs an attractive prospect for active traders but can also cause unnecessary losses for the less informed traders. Many brokers have restricted leverage due to regulations and to try and protect traders from themselves.

In the example above, let’s consider the value of the underlying stock increased to a price of $36.

If you owned the stock, your holding is now worth $3,600. The realised profit is $100 excluding any commission or trading costs.

However, with the underlying stock at $36.00, the CFD would show the same $100 profit but initially required juts $175 to open the position.

Therefore, in terms of percentage, the CFD had a much greater return. Although if the market had moved the other way, the losses relative to the initial investment would also have been much larger on the CFD. This emphasises the impact of leveraged trading on both the risk and reward of a trade.

Why trade CFDs?

Trading CFDs offers several major advantages that have increased the instruments’ rapidly growing popularity over recent years. With the ability to trade short or long on various markets, use leverage and access thousands of instruments, some trading 24 hours a day, investors are taking advantage of the versatility of CFDs as a way to diversify their investment portfolio.

How to trade CFDs online?

If you have taken the time to read through the above, you should hopefully have an understanding of how to trade CFDs. Here is a summary of the key steps:

1. Decide if CFD trading is for you

Trading CFDs online carries an element of risk and can take more time than other forms of investing. You will need to research CFDs, manage your CFD positions, follow market news and decide how to react to it. It is important to understand the risks and dedication that comes with trading CFDs online.

2. Educate yourself

Before trading CFDs, it is imperative to learn as much as possible about investing and CFDs in particular. Any mistake could prove to be costly. There is an abundance of free educational materials such as trading guides provided by many online CFD brokers that can help you to improve your trading skills and knowledge.

Most CFD brokerages will also provide a free demo trading account so that you can practice trading CFDs online with virtual funds in order to familiarise yourself with the trading platforms and practice your trading strategies until you feel confident enough to open a real trading account.

3. Choose a CFD broker

In order to trade CFDs online, you will need a broker account and CFD trading platform to execute your CFD trades. When choosing a CFD broker, there are a few important things to consider such as regulation, commission fees, platforms, tools, education, funding options and customer support. You will find that CFD brokers tend to provide more options than your typical investing brokers that can take care of everything for you.

4. Research CFDs

If you have made it this far then you may be ready to start trading CFDs online! The next step is to research the different markets to see which you have an interest in trading. Perhaps there is a particular industry, product or service that is already of interest to you. Many brokers will allow you to filter CFDs according to various criteria in order to narrow down your search if need be.

5. Have a CFD trading plan

Some of the most important factors that can help determine CFD trading performance can be the trading plan and discipline. It is important to have a solid trading plan personalised to your own needs that includes the money management and trading strategy that you will use. Most experts and professional traders would try to not let negative emotions such as fear, anger and greed affect their trading strategy.

6. Buy and sell CFDs

Once you know what CFDs you want to trade online, you can analyse them to help decide if and when you will place your trades. After placing a CFD trade, you will need to keep track of how it performs and manage it according to your trading plan. Some traders will keep hold of CFDs for the long-term, whereas others may buy and sell CFDs on a daily basis.

Choosing a CFD Broker

We will now look at what CFDs are and the most important factors to consider when looking for an online CFD broker.

Regulation

It is vitally important to ensure that you are using a trusted and established online CFD broker. Many online brokers come and go over the years so it is considered a wise idea to use a regulated broker that has been in business for a long time. A regulated broker has to conduct business according to strict rules and investors are more protected. If a broker is listed on an exchange they have to abide by stricter regulations with frequent audits. Furthermore, if the broker is part of a banking group then they must meet specific capital requirements with the upmost transparency. If a broker claims to be regulated, you can verify this by checking the broker’s license number with the relevant authorities to ensure the regulation is legitimate and up to date.

Instruments

Each online CFD broker will provide a wide range of different instruments, so make sure that the broker you are considering offers the instruments that you wish to trade. If you want to invest in Facebook CFDs or Tesla CFDs, make sure they are offered. It is also worth considering if you will branch out into other markets in the future. If a broker offers multiple markets then it would make the transition in the future more convenient. As there are so many markets to trade, CFD trading hours run 24 hours a day. You will therefore want to make sure your brokers trading hours cover as many of these hours as possible, if not all.

Fees

When trading CFDs online, there are three main fees you need to factor in. This is the spread, commission and overnight holding fee (swap). Not all brokers will charge all fees but it is important to factor these fees into your trading costs. Fees can vary significantly on each broker so it is a good idea to consider them when choosing a suitable broker.

Most CFD brokers will provide traders with free online CFD trading platforms although there are some who charge monthly and volume-based fees, usually for specialised trading platforms that have specific features a professional investor may need. That being said, the free CFD platforms will most likely be sufficient enough for the average retail trader.

Spreads

The spread is the difference between the buy and sell (bid/ask) price which can vary depending on the volume of liquidity and quality of liquidity providers that an online CFD broker has. Some CFD brokers offer fixed and variable spread accounts, some will offer commission free accounts but instead mark up the spread to make up for this. In general, the more liquidity that the broker has, the tighter the spreads can be. It is important to account for the spread when planning your trading strategy, especially if you are planning on using scalping strategy. Be aware that some brokers use dealing desks and will add a mark-up to the spread to cover operational costs.

Commissions

The commission is a fee you pay to the broker for each trade that you place. This is the primary way in which brokers make their money. Commission is usually charged as a percentage of the trade or a fixed amount, sometimes a combination of both. The lower the commission fee, the lower your overall trading costs are likely to be.

Swaps

If you hold a position overnight you will need to pay a swap fee. This is an interest fee for the procedure of moving open positions from one day to another, also known as the rollover. Many CFD traders are day trading so they do not hold positions overnight but if you plan to do so, this is another cost to consider. Some brokers offer swap free Islamic trading accounts which allow Muslims to engage in online trading that conforms with Sharia law

Other Fees

Some brokers will charge additional fees which are worth considering such as withdrawal and inactivity fees. In addition to potential fees for gaining access to the brokers CFD trading platforms, you should consider other online trading costs. Most online brokerages will charge a commission for placing trades in addition to the spread and overnight swap fee. These costs can vary significantly from broker to broker so it is important to consider the overall costs you will incur and the affect that will have on your money management.

CFD Platforms

Each online CFD broker will offer a range of free online trading platforms. If you are already familiar with a specific CFD trading platform then it could be a good idea to choose an online CFD broker that offers that platform. However, if you have yet to use a trading platform then it may be a good idea to start with a broker that offers a user-friendly CFD trading platform which has plenty of tutorials available to help you learn how to trade online. MetaTrader 4 (MT4) platform is often considered as one of the most intuitive and easy to use trading platforms which makes it a popular choice amongst new traders. Some brokers provide their very own proprietary platforms such as eToro, Plus500 and AvaTrade. If you plan to trade on the go, then you should check that they offer web and mobile version of your desired trading platform.

An online CFD trading platform allows traders to access different global markets for speculating on the price movements of various trading instruments without physically owning the underlying asset. In the past, investors and traders would have had to go through an offline broker which meant that the markets were less accessible than they are today. As technology has improved over the years, there are now many online CFD brokerages to choose from. Anyone aspiring to be a successful trader can open a CFD trading account with an online broker and gain access to the brokers CFD trading platforms for online trading from anywhere in the world with an internet connection. Most brokers provide these platforms free of charge and for use on desktop and mobile devices.

Through a CFD trading platform you can view real time bid/ask prices of various assets and load charts that show the historical and current prices of chosen assets over multiple timeframes ranging from tick to yearly charts. You can add technical indicators to these charts to help identify potential trending and ranging market conditions. These indicators can provide trading signals and are often used as part of an overall trading strategy that involves technical, fundamental, sentiment and price action analysis. When you find a suitable trading opportunity, you can execute, manage and close your buy or sell position directly through the CFD platform.

Trading platforms can vary in features, some will offer advanced charting tools for detailed market analysis whilst others can incorporate news feeds and other features to assist with your trading. Depending on your individual trading requirements, make sure the platform offers all of the tools you need to trade with efficiency. It could be a good idea to open demo accounts on multiple platforms to compare them and see which you deem more suitable for your own needs.

Leverage

Nearly all CFD brokers offer leveraged trading via their CFD platforms. Leverage basically means that you can open a position larger than you could without it. If for example you had leverage of 1:50 and a trading account balance of $1,000, you could effectively open a position size of $50,000 (1,000 x 50 = 50,000). Although leverage can increase profit potential, it also increases trading risk and thus, can lead to large losses. It is imperative that you have a thorough understanding of leverage and the significant risks involved before you start trading online. Check the broker offers a leverage that you require via your preferred CFD platform.

CFD trade example

If you wanted to trade a stock with an asking price of $20 and buy 100 shares, this would traditionally have cost $2,000 ($20 x 100). With a CFD broker who requires 5% margin, you could open this position with just $100 ($2,000 / 100 * 5). Leverage will vary between brokers and you will need to factor the spread, commission, swap and any other fees into each trade.

Most reputable CFD brokers will offer negative balance protection, which ensures that you will not end up owing your broker more than your initial account balance. They will close out your trades once your margin is used up to prevent further losses.

Education

Many of the best CFD brokers will provide their own educational materials such as trading guides, webinars and seminars. This can help beginner traders learn more whilst honing their trading skills. Even the more advanced traders can benefit from further education. If you are new to trading and need as much guidance as possible, you might want to explore our best brokers for beginners.

Tools

Some CFD brokers will offer clients trading tools that can assist with trading. These tools range from technical chart analysis and economic calendars. If you would like additional tools, see what a broker has to offer and if these come and an extra cost or are free to existing clients.

All CFD trading platforms come with a range of free built in trading tools to assist with your online CFD trading, helping to improve overall efficiency and performance. These can include technical indicators for analysing charts such as a moving average, MACD, Bollinger Bands, RSI, CCI and many more. Some platforms offer fundamental analysis tools such as built in economic calendars to efficiently keep track of the latest market news releases. They may also have trading calculators to help with planning your trades. The more advanced platforms will have depth of market (DOM) with level 2 pricing and sentiment tools that show how many traders are buying/selling a particular instrument.

If you require a specific set of trading tools or would like access to as many as possible, you should check what CFD trading platforms the broker offers along with the trading tools included. Some trading tools are stand alone and thus will not be incorporated into the CFD platforms but can still be very useful.

Signup

You will need to make sure that the CFD trading platform will run on your computer, VPS or mobile device by checking the specification requirements. Each CFD broker trading platform will have a minimum deposit requirement which is worth considering.

Funding

Methods of funding and withdrawing from your online trading account can vary from one CFD broker to another. Check what methods they offer and ensure that it is suitable and convenient for you. Some brokers will offer online payment processors such as PayPal and Skrill which and be processed faster than other methods which can take up to 5 days.

Support

As the CFD market contains so many different instruments and runs 24 hours a day, you will need to ensure that the broker has adequate customer support to answer your questions as and when necessary. Consider the location of the broker and what days/time they offer their support. Ideally, the broker should provide support in multiple languages, at least 24 hours a day and 5 days a week. Check that they have a method of contacting support that is most convenient for you. Online chat can be quick and easy, but some traders may prefer to speak to someone over the phone. You should also consider the brokers office locations as they may be in a different time zone to you which could affect the response time.

ESMA Regulations

New regulations and measures are constantly being put in place to protect retail CFD traders. European regulators want to clamp down on how CFD brokers conduct their business and how products are offered to clients. Research from European Securities and Markets Authority (ESMA) shows that around 80 to 95% of investors are losing their investment which is not always through fault of their own.

Specifically, when a broker uses a dealing desk there can be a conflict of interest. Instead of executing a trade directly to the liquidity providers, it goes through a dealing desk which can lead to delays (slippage) and spread mark-ups. This makes it even more difficult for retail traders which is another reason why it is so important to choose a reliable broker.

Amongst the new rules introduced in 2018 by ESMA for European traders are:

Leverage Limits

The maximum amount of leverage offered to European CFD traders has been capped. Some brokers will lift this limit if you meet certain requirements and qualify as a professional trader. To qualify you would usually have needed to have conducted a large amount of transactions, have a significant portfolio and experience in the financial industry.

  • 30:1 for major currency pairs
  • 20:1 for non-major currency pairs, gold and major stock indices
  • 10:1 for commodities other than gold and non-major stock indices;
  • 5:1 for single stocks and any underlying not otherwise mentioned
  • 2:1 for cryptocurrencies

Margin Limit

A margin close out rule on a per account basis. This will standardise the percentage of margin (at 50% of minimum required margin) at which providers are required to close out one or more retail client’s open CFDs.

Negative balance protection

Negative balance protection on a per account basis. This will provide an overall guaranteed limit on retail client losses.

Restriction on marketing and incentives

Brokers must clearly state the percentage of clients who are losing money and not offer any incentives to attract new clients to trade CFDs.

Conclusion

CFD trading is a popular choice for active investors who would like to trade leveraged positions with access to buy and sell thousands of trading instruments around the clock. CFD trading can be suitable for scalping, day trading and swing trading.

However, it is important to understand the significant risks involved with trading CFDs online, especially when using leveraged positions. Most experts would suggest trading on a demo account with virtual funds to begin with.

This can be a useful way to familiarise yourself with how to trade CFDs and using trading platforms whilst allowing you to practice your trading strategies until you feel confident and produce consistent results. Most CFD brokers provide unlimited demo accounts free of charge.

CFD trading requires patience, discipline and lots of practice. According to our research across hundreds of CFD brokers, most online CFD traders actually lose money. Most aspiring traders start trading on a demo trading account before going live.

Take your time to research brokers and do your own due diligence, the above information is only for educational purposes and not advice. Please feel free to view our best CFD brokers if you need some further inspiration before you get started.

About the Author

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Richard Montana
Richard has many years of experience in broker research, testing, analysis and reviews. He knows what to look for through years of trading himself with different brokers and listening to the feedback of others.

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For all of our broker reviews, we research, validate, analyse and compare what we deem to be the most important factors to consider when choosing a broker. This includes pros, cons and an overall rating based on our findings. We aim to help you find the best broker according to your own needs. You can read more about our review process.


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