GUIDE | TRADING BASICS | BEGINNER
Contract for Differences (CFDs) Explained
Learn how to trade CFDs with our
comprehensive guide
What are CFDs?
CFDs, or Contracts for Difference, are financial instruments offering traders a dynamic way to trade markets without owning the underlying assets. However - and particularly for traders at the start of their trading journey - it can be difficult to fully understand the advantages and disadvantages of investing in and trading CFDs.
For that reason, FXTM has created a guide to CFDs, answering the big question, 'what is CFD trading?' In this guide, we will be taking a balanced look at trading CFDs, giving you access to all the information you need to decide whether it's the right instrument for you, and how these assets can be tailored to suit your trading style.
Understanding what CFDs are
The term CFD stands for “contract for difference”, a popular product that enables people to trade a wide range of financial markets. Brokers offer CFDs on instruments such as forex, commodities, indices, and spot metals.
CFDs are a form of derivative trading. As in, they derive their value from the movement of an underlying asset. They allow traders to trade price movements without actually owning the underlying asset.
Understanding what CFDs are
The term CFD stands for “contract for difference”, a popular product that enables people to trade a wide range of financial markets. Brokers offer CFDs on instruments such as forex, commodities, indices, and spot metals.
CFDs are a form of derivative trading. As in, they derive their value from the movement of an underlying asset. They allow traders to trade price movements without actually owning the underlying asset.
Engaging in a Contract
When traders choose to trade CFDs, it means that they are engaging in a contract between themselves and the broker. The trader – the “buyer” – and the broker – the “seller” – agree to a contract which speculates on the price of an asset in market conditions.
By not owning the underlying asset, CFD traders can avoid some of the disadvantages and costs of traditional trading.
How CFD trading works
Engaging in a Contract
When traders choose to trade CFDs, it means that they are engaging in a contract between themselves and the broker. The trader – the “buyer” – and the broker – the “seller” – agree to a contract which speculates on the price of an asset in market conditions.
By not owning the underlying asset, CFD traders can avoid some of the disadvantages and costs of traditional trading.
How exactly does this contract work?
Essentially, profit and loss are calculated by looking at the difference in price between when a contract is entered and when it is exited. That means that the broker – or ‘seller’ – who enters into this contract with you will pay you the difference between the price at the beginning of the contract and the price at the end.
Calculating profit and loss
If a loss is made, the trader – “buyer” – will pay the broker the difference.
The key calculation to work out your profit or loss is the difference between the price at which you enter and the price when you exit, multiplied by your number of CFD units. CFDs are available across a huge range of markets. With FXTM for example, CFD traders can choose from CFDs on shares, indices, commodities. To find out more about the individual CFDs on offer, you can visit FXTM’s detailed contract specifications page.
Three steps to get you started
Between share CFDs, index CFDs and commodity CFDs, choosing your underlying asset is an important choice. Not sure which to choose? Check out our beginner’s guides to forex and forex trading for a broad overview of the underlying assets you can choose from.
Alternatively, discover which markets are hitting the headlines by following the latest market analysis reports and videos. You can discover the particular specifics of each CFD by visiting a broker’s contract specifications page, where you can find out about instrument leverage specifics and competitive trading costs.
Once you’ve decided what kind of CFD you’re going to trade, it’s time to decide on your position. Put simply, if you think the price of your asset will go up you can open a long position (buy), or if you think the price will fall you could open a short position (sell).
To decide what kind of trade you want to open, you can use a broad range of indicators, charts and signals. To find out more about popular strategies and indicators, you can visit our forex strategies guide.
Next, choose the size of the position you want to open. The value of a unit of the CFD you’re trading will depend upon the instrument, so you should calculate the number of CFD units that can work best with your trading strategy.
CFD Margin and Leverage
Margin and leverage are important considerations when trading CFDs.
One of the key advantages of CFD trading is that you only need to deposit a small percentage of the total trade value. FXTM CFD traders only require a margin starting from 3 percent. FXTM’s margin calculator is a useful tool to help you to manage your margin on the FXTM Standard account.
Leverage is higher with CFDs than with traditional trading.
Traders use a smaller portion of their own capital when opening a position, which allows for potentially bigger returns. That said, it’s important to remember that leverage carries the same potential to increase losses as it does to boost profits.
CFD Markets
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Choosing Your CFD Trading Platform
Hone the power of CFD trading with MetaTrader
MT4 and MT5 are complete with the latest charts and tools to help you advance your CFD trading strategy. With FXTM, you can use the industry’s most popular platforms to trade CFDs across shares, indices, commodities. MetaTrader is complete with updated tools to give you a smooth, user-friendly CFD trading experience.
Discover how the latest features can improve your market understanding and analysis.
Most of our traders lover trading on MT apps from their mobile. These apps enable you to access the markets from the palm of your hand, wherever you go. Download today to manage your trades in seconds, view your trading accounts and access live currency rates.
Trading tools for CFD traders
History of CFD Providers
CFD providers give traders access to the online markets with varying margin requirements, account types and trading platforms. The instrument has only been available to retail clients since the late 1990s. However they quickly picked up momentum.
Online CFD providers opened the door to a host of new possibilities for traders, including adding derivatives to their portfolio. Today the London School of Economics estimates that CFD trading accounts for more than a third of all stock market trades in the UK.
Benefits and Risks of Trading CFDs
Although CFDs spare traders from many of the costs of traditional trading, CFD traders are required to pay the costs of spreads. CFD traders have to pay the spread on entry and exit positions, meaning that it’s potentially harder to make small profits. The spread cost must be factored in to the calculated profits and losses resulting from CFD trading.
The good news here is that the FXTM Advantage account offers typically zero spreads on FX majors and as low as zero on Gold, which are CFD products.