If you’ve had the slightest bit of history with financial markets, you’ve probably come across the “CFD trading disclaimer” on a few brokerage websites. In reality, it could be a little scary, knowing all brokers claim that trading CFDs is extremely high-stakes and that if you do it, you’re doing it at your own risk.
But that’s exactly what they said about forex trading, too, when retail trading became a thing, and look where that’s gotten now. So, just like any other novelty you come across, it’s best to leave your bias aside and get deep on the eternal question: “What is CFD Trading?“
Learn the nitty gritty details about this asset class and find out if CFD online trading is right for you.
CFD Trading Simplified
In its simplest form, CFD (Contract for Difference) trading happens when you speculate on the future price movements of a financial asset without actually and physically owning it. Regardless of the state of the market (whether bullish or bearish), CFD trading helps you open trades to predict future price movements of a wide variety of assets, including forex pairs, crypto, stocks, commodities, and precious metals.
The most obvious difference between CFD trading and other types of trading is the fact that you can earn money from different assets without physically owning them. Aside from that, it allows you to profit from both bearish and bullish markets.
Advantages of CFD Trading
CFD trading is an attractive option for many traders because its unique features provide a great deal of trading freedom. Here’s why you might also be interested:
Leverage Trading
By using leverage trading while dealing with CFDs, you can easily expand your reach to the global market and participate in trades larger than your actual capital would’ve allowed. Just keep in mind that as fruitful a tool leverage trading can be, it also increases your risks of capital loss and possible liquidation.
Diverse Markets
One of the best things about trading CFDs is that they can practically be used in all financial markets. So, whether you’re interested in trading forex, crypto, commodities, or shares, you can benefit from the appropriate CFD trades.
Short Selling Opportunities
Unlike some markets where you can only benefit if the asset raises in prices, CFDs allow you to take advantage of both rising and falling markets.
Means of Hedging
You can use CFD trades to hedge yourself against other CFD trades that might fail or any other physical positions you might have opened.
How to Trade CFDs
Trading CFDs is a pretty straightforward process. While there goes a lot into studying your target market and practicing to make perfect, executing a trade is not complicated at all.
First, you choose which market you’re interested in. No matter which one you choose, you should make sure to study it well before making any trading decisions.
Next, you do the actual speculation. If you believe the prices are going to rise, you go long (buy). On the other hand, if you think the market’s headed south, you sell the asset, AKA go short.
After you determine what your move is going to be, you get to the technicals. This means defining your trade size, applying leverage, and setting the appropriate stop-loss and take-profit orders.
Finally, you execute the trade and monitor it to take appropriate actions upon new changes and updates.
Key Terms in Trading CFDs
Before we can get into a real-world example of CFD trading, there are some terms you should fully understand. Belowe, we will explain each of them concisely.
1- Spread
When trading in financial markets, asset prices are always shown in pairs. First, there’s the bid price, which is the highest rate the broker will pay to buy the asset from you. Then, there is the ask price, which is the minimum rate you need to pay to buy the asset from the broker. The difference between these prices creates the spread, which, in a way, is considered to be your compensation to the broker.
2- Leverage and Margin
The next topic is leverage and margin trading. When you want to take part in larger trades with a smaller capital, you can use leverage trading, also known as margin trading.
Basically, your broker will provide you with extra capital to increase your market exposure, which can amplify both your gains and losses.
The leverage is a ratio which states how much you can trade in relation to your initial capital. For example, a 30:1 leverage means you can trade 30 times worth of your actual capital.
On the other hand, you’ll need to have a certain amount of money in your CFD trading account to open and maintain a leveraged position. This capital requirement is known as the margin.
3- Pips
Percentage in point, or pip for short, is the smallest unit of price movement in different markets, including forex, stocks, and crypto. Pips help standardize price changes.
4- Lot Size
Lots are used to measure the amount of assets traded in forex and other financial markets. They are important because they can ultimately impact your risk and reward. For example, using larger lot sizes can increase both your gains and losses.
Standard, mini, and micro lots are popular trading measurements. While a standard lot translates into 100,000 units of a currency pair or other asset, a mini lot encompasses 10,000 units. As for micro lots, they’re 1% of a standard lot, providing access to 1,000 units of assets.
5- Take Profits and Stop Losses
As a CFD trader, one of the most important things you need to master is risk management and its principles. Stop losses and take profit levels are some of your most handy tools for risk management.
Basically, a stop-loss order ensures the position is automatically closed when the market moves against your direction and reaches a certain price level, AKA the stop-loss level you had set before.
On the other hand, take-profit orders ensure the trade is automatically closed when it reaches your profit target.
Costs of CFD Trading
Spreads, commissions, overnight fees, and currency conversion fees are some of the major costs you might face as a CFD trader.
We’ve already gone over spreads, but brokers might also charge a commission on every trading lot. So, picking the right CFD trading platform becomes extra important for you to successfully avoid extra expenses.
Additionally, if you hold your positions open for a few days, you might also be charged an overnight fee (swap), which you should also consider.
Finally, if you’re not trading in USD for any reason, you might be subject to currency conversion fees as well.
CFD Trading Example
Let’s say you’re interested in trading CFDs on Gold. The current market price of Gold is $1,900 per ounce, and you believe the price will go up. You open a long position (buy) for 1 CFD on Gold at $1,900. The broker requires a margin of 10%, meaning you need $190 to open this position.
As you predicted, Gold’s price rises to $1,950 per ounce. To calculate your profit, determine the difference between the opening and closing price, which comes at $50 per ounce ($1,950 – $1,900). Since you’re trading 1 CFD (representing 1 ounce of Gold), your profit is $50.
As for your costs, we’ll keep it simple for the sake of this example. Suppose the broker’s spread is $1, meaning the price you buy at is $1 higher than the actual market price. This will slightly reduce your profit. At the same time, if you held the position overnight, you’d pay a small fee for that.
Finally, you close your position at $1,950, locking in your $50 profit.
CFD Trading Strategies
Just like trading any other asset class, CFD trading strategies also follow the same general rules and objectives. Based on your risk tolerance and trading preferences, you can choose a more rapid and time-consuming strategy like scalping or something more laid-back like trend trading or swing trading.
Still, you’ve got the option to choose from the following strategies: Scalping, day trading, range trading, swing trading, trend trading, hedging, and more!
Selecting the Right CFD Trading Platform
To pick the best CFD trading platform, you need to consider a few factors. First, make sure your broker of choice is properly regulated to protect your capital. Next, check to see if their trading platforms are suitable for trading CFDs.
For example, MetaTrader 5 is a world-renowned trading platform that supports CFD trading and many other instruments.
You also need to make sure that the broker you’re considering supports the markets you want to trade CFDs in. Additionally, take time to understand their leverage and margin requirements.
Lastly, make sure you’re fully familiar with the fee structure of the broker, so you don’t get caught off guard when trading.
Here at ITBFX, we can help you ease into your CFD trading journey with a wide variety of asset classes, the most up-to-date platforms, 24/7 support, and comprehensive educational material that can teach you everything you need!
Is CFD Trading Legal?
To answer this question, you need to check jurisdictional laws. For example, while it’s fully illegal for retail traders in the US to participate in CFD trading, Uk citizens, on the other hand, can trade this asset class and might even be exempt from tax requirements.
Pros and Cons of Trading CFDs
The advantages of CFD trading are as follows:
- The potential of increased returns using leverage
- Ability to trade in both rising and falling markets
- Access to various financial problems via one platform
On the other hand, the disadvantages of CFD trading include:
- High risk, especially combined with leverage
- Possible accumulation of fees, especially for long-term traders
- Heavy reliance on market volatility, leading to heightened risks
Tips for Successful CFD Trading
Last but not least, there are some tips for succeeding in your CFD trading journey:
- Stay educated: From a broader perspective, it doesn’t matter what market you’re trading, you need to keep educated on the latest market shifts and updates. This is especially important for CFD traders, both novice and seasoned.
- Start small: Starting small and building confidence is a great CFD trading tip for those who are just getting started with contracts for difference. Using a demo account during this stage or any other stage of your trading is a smart move that will allow you to test the waters and any new strategy you might have in mind.
- Keep your emotions in check: After developing your trading plan, you need to master the art of trading with discipline. No matter if it’s fear or greed that’s driving you toward a trading decision that’s not well-thought, you need to snap out of your emotions and get as close to a robot as possible.
- Reflect on past trades: It’s a great idea to keep a trading journal, where you analyze your previous escapades, determine why they were successful or why they were not, and find action plans to improve things next time.
Wrap Up
Contracts for difference, or CFDs for short, allow traders to speculate on the future price movements of different assets and instruments without holding any actual ownership of them. They can be extremely beneficial but equally as risky. So traders should approach them with caution.
Some benefits of CFD trading include the ability to trade both falling and rising markets, the amplification of possible gains using leverage, and diversity in terms of available asset classes.
On the other hand, the leverage can magnify potential losses as well, and broker fees might also accumulate for positions of this nature.
As a result, it’s important to fully educate yourself on the market and how you can trade first. Create a well-thought CFD trading plan and test it out on our demo account to make it perfect. Only then can you enter the market for real! Still, don’t forget to start small and manage your risk religiously.
CFD, or contract for difference, is a type of trading that allows traders to speculate on the price movements of various assets like currency pairs, crypto, stocks, and commodities, without physically owning them.
The legality of CFD trading depends on the jurisdictional laws of where you live. While CFD trading is forbidden for retail traders in the US, you need to check the federal laws of your country of residence if you're not from the US.
With years of experience in providing extensive trading services for a client base from around the globe, ITBFX is a great platform to start your CFD trading journey. With 24/7 support, great educational material, low fees and commissions, and modern and fast trading platforms, we can help you grow!
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