A Contract for Difference (CFD) is a simple and convenient financial instrument that provides maximum transparency and low costs. It can be used to make trades on Shares, Indices, Forex, bonds, ETFs, and Commodities without actually buying the underlying asset itself. The trader opens a CFD on an asset at a specific price, and the difference between the opening price and the closing price (on a successful trade) is the profit. Most brokers offer between x200 and x400 leverage on CFD trades.
Leverage allows traders to open CFD positions using the broker’s money (subject to a margin requirement). Potential profits are increased – as are potential losses.
You decide that you want to buy Amazon Shares. Instead of purchasing 1,000 Shares of Amazon from a Stockbroker, you use a trading platform to open a CFD on a lot of 1,000 Amazon shares. If there is a $5 per share fall in the price of Amazon, you will make a $5,000 loss. If there is a $5 rise in the price of Amazon, you will receive a $5,000 profit. The advantage of CFDs is that you didn’t buy the shares, reducing your trading costs.
Why Trade CFDs?
Brokers provide high leverage on most CFD assets. x400 is normal, although highly volatile assets like cryptos may only be permitted x20 leverage. Leverage allows you greater exposure on each open position, but you must also maintain a margin requirement (usually between 3-50%) to cover each open position. Leverage can potentially increase your profits, but also your possible losses.
Access to Global Markets via One Platform
CFDs give ordinary traders instant access to over 4,000 international markets. Depending on your broker, you can trade day and night with minimal restrictions as there is almost always an exchange open somewhere in the world.
No Restrictions on Shorting or Borrowing
When you trade CFDs, you never buy the underlying asset. This means that you can short the financial instrument at anytime, with no borrowing requirement. There are also no separate margin requirements for long and short positions.
No Fees on Order Executions
Any good CFD broker will offer a full range of order executions, such as stops and limits. Some may offer more sophisticated contingent orders. These orders should be fully automated and completely free.
CFD brokers make their profits via spreads (the difference between the ask price and the bid price). Spreads may be fixed or variable and may differ according to assets and trader account types. There shouldn’t be any other fees or commissions relating to actual trading, with the possible exception of rollover.
Unlimited Day Trading
Unlike traditional brokerages, CFD brokers usually place no restrictions on day trading. There are no minimum capital outlays, nor limits on the number of day trades. You can often open an account with as little as $250 and immediately begin day trading.
Wide Choice of Assets
CFD traders can specialise or diversify as it suits them. Most brokers offer a range of Forex & Crypto pairs, stocks, indices, commodities, bonds, and ETFs. As a CFD trader, you are not restricted to any particular asset class.
How to Trade CFDs Safely
Check your Spreads
CFD brokers make their profits via spreads. This is a perfectly legitimate practice and honest brokers are very clear about spread costs. It’s your responsibility to check the spreads for each trade and understand how they may affect your potential profit and loss – particularly if you are opening small positions. Spreads can be fixed or variable and some trader accounts may provide lower spreads than others.
Choose a Registered Broker
Understand the Risks
CFD trading offers potentially high profits due to the inherent volatility of the underlying assets. But the markets can move fast in either direction and can experience sudden downturns in response to global events. Even experienced traders sometimes lose money. It’s important to discuss risk management with your account manager and to make sure that you understand how to use leverage wisely. As a CFD trader, you should expect to sometimes lose money and should never invest more than you can afford to lose.