CFDs are popular financial instruments which are key components of a trader’s portfolio. 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.
The term CFD stands for contract for difference which are a type of trading instrument and a popular gateway for investors to enter the financial markets. They are offered by brokers alongside other types of common assets like forex, commodities and spot metals. Unlike these however, CFDs are a form of derivative trading. This means that they derive their value from the movement of an underlying asset.
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. While the trader speculates on financial instruments, it is important to note the main distinction between CFDs and traditional trading:
CFDs allow traders to trade price movements without actually owning the underlying asset. By not owning the underlying asset, CFD traders can avoid some of the disadvantages and costs of traditional trading.
So, 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. 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 and enjoy several advantages over trading these instruments directly. To find out more about the individual CFDs on offer, you can visit FXTM’s detailed contract specifications page.
Find out about the advantages of trading CFDs in our video:
Trading CFDs with an experienced broker is a simple process. Once you have opened your trading account, you’re just a few steps away from selecting your instrument and starting to trade. Don’t forget – you can always try out your CFD trading preferences using a Demo account to ensure you’re comfortable with your chosen instrument before you enter the live markets.
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.
CFDs can be traded on the industry’s most popular trading platforms, including MetaTrader 4 (MT4) and MetaTrader 5 (MT5). These platforms are equipped with all the tools you need to trade CFDs, including over 50 technical indicators and charting tools. You can also trade on mobile apps, allowing you to keep track of your profits and losses in real-time, on-the-go.
Having established the key, basic calculation of working out your profit or loss with CFDs (the difference between the price at which you enter and the price which you exit, multiplied by your number of CFD units), let’s take a look at how this calculation can be applied in practise.
If you think the price of General Electric stock will increase over time, you could buy CFDs on #GE with FXTM. The opening price is 31.36 and you buy one lot at this price, meaning that the notional value of your contract is $3,136.
To work out how your position has fared, you simply need to calculate the difference between the opening price and the closing price. If the closing price of General Electric stock is 31.94, for example, the difference is 0.58. This difference, multiplied by your number of CFD units, is how you calculate the profit or loss made on that particular trade.
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. Traders can use the FXTM leverage and margin calculator to work out the specific requirements for every type of FXTM account.
Enter the markets with FXTM to trade CFDs on a range of instruments. With FXTM you can trade:
FXTM have a range of trading accounts on offer for CFD trading. These are suitable for both beginner and advanced traders alike, and come with an array of competitive leverage and margin requirements. Discover more about each main account type below:
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.
You can also trade from your mobile with FXTM Trader. This revolutionary investment app enables 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.
Expert Advisors are programmes which use algorithms to trade the markets. They respond to parameters you set to send out trading instructions on your behalf. This saves you time – you don’t have to manually open, modify or close your position on an asset. It’s another way that the MetaTrader platform makes it possible to fit online trading into a busy schedule.
The economic calendar is an indispensable tool for fundamental analysis. The tool displays over 500 indices and economic events clearly on the price chart. Macroeconomic indicators are updated in real time, meaning that you can keep your finger on the pulse of the markets at all times.
The Strategy Tester allows traders to evaluate their trading strategy and optimise the platform’s Expert Advisors. The tool can test over 40 characteristics and issue a comprehensive report.
Traders can choose from an expanded selection of 46 objects including Gann, Fibonacci and Elliott Wave tools.
CFD providers give traders access to the online markets with varying margin requirements, account types and trading platforms. CFD providers are a fairly modern invention – 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.
When it comes to choosing a broker to trade CFDs with, it’s important to make the right choice. Traders should look for brokers who are regulated, secure and experienced, including award-winning brokers like FXTM. There are certain attributes which set FXTM apart from the crowd:
CFDs are chosen by investors due to the wide range of advantages associated with the contracts. By not owning the underlying asset, traders can avoid several of the costs associated with traditional trading.
Brokers typically offer CFDs with higher leverage than other traditional financial instruments. FXTM offers a leverage up to 1:1000* which can boost traders’ potential profits. The lower margin requirements of CFDs mean that potential returns of greater overall – however, traders should bear in mind that leverage can, of course, boost losses as well as profits.
CFDs grant traders the ability to go both long and short on instruments. Since the underlying asset isn’t actually owned, traders have greater flexibility and can shorten CFD trading instruments without worrying about additional costs.
Most brokers offer CFDs on a wide range of markets. Trading CFDs, you can enter the commodity and indices with FXTM – and enjoy the opportunities and advantages associated with each.
While there are many benefits of CFDs, there are drawbacks that traders should bear in mind when deciding on their trading instrument.
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.
CFDs do not come without risks. Trading these instruments can be risky and fast-paced, and traders should be careful to have a thorough risk-management strategy in place. Placing stop-loss orders can potentially help to minimise potential losses, but do not eliminate the risks altogether.
With regards to tax, there is no stamp duty to pay on CFDs since the underlying asset isn’t owned. However, capital gains tax still applies. Overall, tax represents one of the areas that CFDs save traders costs compared to traditional trading.
What makes a CFD trader successful? At FXTM, we believe that a successful trader is an educated trader. Traders who gain a solid understanding of the markets and create a thoroughly researched trading strategy are likely to be more prepared to take on the live markets. That’s why it’s important for traders to make the most out of educational resources to help them build their own personalised trading strategy. It’s particularly important to create a strategy in order to minimise the impact emotions have on important trading decisions.
Take a look at FXTM’s free educational resources here.
There are several popular strategies to bear in mind when trading CFDs.
With swing trading you’re looking at assets that will likely have short-term price moves you can exploit. Leaving your position overnight attracts more risk because of the potential for unexpected events to affect the market while your attention is elsewhere. Find out more.
As the name suggests, day traders open and close trades over the course of the day, usually holding positions for only a few hours. Day trading removes the risk that occurs when you leave a position open overnight. Find out more.
Scalp traders target intraday price movements and aim to make very small, very frequent profits. They typically only hold positions for a few seconds or minutes and exploit small opportunities while they trade with the prevailing trend. Find out more.
Trade CFDs with a global, award-winning broker. Open your account today.
*Leverage is offered based on client’s knowledge and experience