CFD Trading – What is a CFD (Contract for Differences)?
Contract for difference is a particular type of contract, due to which two parties can agree on the purchase and sale of the financial instruments they need, based on the difference between the opening and closing price.
If the closing price is higher than the opening one, the buyer receives the profit from the seller, which is calculated as the difference between these prices. If the opposite happens and the opening price is higher than the closing price, the buyer will pay the difference.
CFD trading provides traders with many exciting opportunities. In particular, holding their position is enough to make a minimum deposit, while in another trading, such a deposit should be quite substantial.
Many traders like CFD investments for their flexibility. In fact, CFD traders can use any trading strategies without any limitations. Also, the trader decides when to trade, choosing the most comfortable time for work.
Considering what are cdfs, it is important to understand the essential difference of this instrument from bonds, stocks, and other assets.
Trading CFD does not imply the physical availability of an asset. By choosing this tool, traders work with the unit tied to security or any other asset, and the results of their trade will directly depend on the value of the chosen asset. Thus, talking about what CFD trading is, it is worth noting that such trading implies an opportunity to earn on changes in the price of securities without the need to purchase this asset. In other words, by buying a trading contract, an investor gets an opportunity to earn only the difference between the contract opening and its closing.
Long Trades or Short Trades (Short-selling)
The CFD forex is not as simple as investors would like it to be. Many beginning investors are confused, whether to open a long or short position. They try to understand what the difference between them is. Everything is not so complicated, and we will figure this out together with you.
The primary difference between long and short transactions lies in an action taken by the investor – the purchase of an asset or its sale. When an investor buys an asset and plans to sell it at a higher price in the future and make a profit on the price difference, he initiates a long transaction.
In case of a short transaction, by contrast, the investor waits for the price of the asset to rise, after which he sells it and plans to wait for the price of the asset to fall to buy more of these assets in the future. Thus, the investor either acquires more assets at the same price or returns the asset to himself and makes money on the difference in rates.
A typical short transaction involves borrowing an asset, selling it, waiting for the price of that asset to fall, and then repurchasing the asset. The investor recovers as much as he borrowed but still makes a profit because he was able to buy the asset at a lower price.
It is important to understand that opening both long and short positions requires the ability to analyze the market and the investor sense. Take full responsibility for all your decisions because each of them can bring you both good profits and substantial losses. Study how to trade CFD and decide which CFD broker will offer you the best conditions for trading. Many investors have long made their choice in favor of Exness, and they are not mistaken because this broker allows you to trade a wide range of other popular instruments and earn money on it, in addition to CFD. Moreover, Exness offers a convenient CFD trading platform and valuable tools helping traders and investors make good decisions and monitor the market.
What is Leverage in CFD Trading?
Before you understand how to trade CFDs, you need to know about the peculiarities of leverage in trading. By taking advantage of leverage, you get the opportunity to open a position without paying the full price for it.
All you need to do is to make a minimum deposit, which is called a margin, and you will have access to a wide range of trading opportunities.
When working with a CFD, you do not acquire a physical asset, and therefore, you will not need to pay its full cost if you choose to use leverage.
For example, if you were to open a position of $45,000 using leverage, you would only pay 5% of that amount, that is, only $2,250, and the position would be successfully opened. If the market moves in the direction you want, leverage can provide you with good earning opportunities, but it is important to remember that your risk increases in proportion to your potential profit, and therefore you must use this tool very wisely.
“What is CFD Margin or “Trading on Margin”
What does “Trading on Margin” mean, and why is it often used in CFD trading? By trading CFD, an investor can open a position without paying the full price. He pays a minimum margin, which is a certain portion of the total size of the position, and this is quite enough for the successful opening and maintenaning this position.
You need to know that there are several types of margin, namely deposit and maintenance. What is the difference between them? The first is used to successfully open trades, while the second margin is used when the market goes against the trader and trade can become unprofitable. This loss can be so catastrophic that it will not be covered even by the deposit margin and any other funds available in the investor’s account.
The investor’s task is to control his losses and not allow their rapid increase because if this happens, the broker may require replenishing the account. If the investor does not fund the account, the position will be closed, and losses will be inevitable.
Hedging with CFD Trading
When investors consider investments in one or another asset, they are guided, first of all, by the potential profit they can make. Profit is also important for such instruments as CFD, but it is often used to hedge the losses of the investor’s portfolio.
How does this process work? Let’s say you bought Apple stock, but suddenly a profit and loss statement was released, which did not meet investors’ expectations. This caused a short-term decline in the stock price, which necessarily hurt your equity.
How can an investor recoup his losses? By using the CFD deal he opens a short position. He makes a profit on this position, which partially compensates for his losses even in case of a significant decline in the value of Apple stock.
How do CFDs Work and Who are CFD Investors?
The main peculiarity of CFD trading is the absence of physical delivery of goods. In their work, investors focus precisely on changes in the value of the asset. Simply put, CFD investors place their bets on whether the price of goods will fall or rise. The difference between the buy and sell price is of primary interest to CFD investors.
Commission and Spread
Before you open a short or long CFD, you must first understand everything about CFD prices. There are two types of prices – the buying price and the selling price. At the buy, price opens long CFD, and short, respectively, open at the sale price.
If you compare the asset’s current value with the buy and sell price, you will notice that the buy price will be higher than the current market price, while the selling price will be slightly lower. As a rule, the spread successfully covers the cost of opening a CFD transaction. Thus, to best reflect the value at which the trade will be executed, the selling price and the buying price will be slightly adjusted.
Perhaps the only exception to the rule is a CFD on a stock. In this case, the spread will not be charged, and the selling and buying price will be as close to the underlying price as possible. Working with this instrument, the trader pays a commission to the broker. The need to pay commission makes CFD trading very close to the traditional trading on financial markets.
Lots – Deal size
Some beginning investors are frightened by a very significant difference in deal size in CFD trading from the similar deal size in other assets trading. All these fears are false because there is no significant difference. Like any other assets at financial markets, CFD is sold and bought with standard lots. The contract size will directly depend on the underlying asset, and in fact, the lot size in CFD trading is often similar to the lot size of the assets on the market.
For example, you want to buy 100 shares of Apple using a CFD. In this case, you will need to purchase 100 Apple contracts. The situation with other assets is similar.
If we compare trading with CFD with options, we will see one significant difference. Options have a definite expiration date, while CFD trades do not possess any fixed time frame. To close a position successfully, the investor will not have to wait for a specific time because he will be able to do it simply by opening a deal in the opposite direction. If you want to close a deal to buy 300 shares, you will need to open a deal to sell those same 300 shares.
Another important feature to keep in mind is maintaining the CFD position. If the day trading time ends and you do not close the CFD position, be prepared to pay an overnight financing fee. However, by choosing forward contracts, you will not have to pay an overnight financing fee, because this fee is already included in the spread.
Profit and Loss
The calculation of losses or profits for such an instrument as a CFD may seem complicated at first sight, but there is a clear formula that allows simplifying this process.
So, to calculate the profit or loss, you will need to multiply the total number of contracts by the value of each of them (expressed as a movement point). The result must be multiplied by the difference in points between the cost of opening and closing the contract.
Profit/loss = (number of contracts x cost of each of them) x (close price – open price)
Also, keep in mind that for more accurate calculations, you will need to additionally deduct all the commissions and fees you have to pay from the result. Examples of such fees could be those for a guaranteed stop, overnight financing, and so on.
Why Trade CFDs with Exness?
Choosing a broker can be a real problem for many newbies. What to pay attention to and how to make the right choice?
First of all, you should take a look at the functionality offered by the company. Your possibilities in CFD trading should not be limited by anything. It is also very important that the company has been on the market for a long time and has an impeccable reputation. And, of course, loyal commissions will be an important fact, because if these commissions are high, they can eat up all the profits gained from trading.
When you trade with Exness, you get access to all markets and assets, particularly CFD.
CFD Trading Strategies
As with any other asset, successful CFD trading involves the use of a strategy. Straight away, we will look at the most popular ones.
With the day trading strategy, you open a trade and close it on the same day, without leaving it overnight. With this strategy, you will have time to make an informed decision, but you can eliminate the risks, significantly reducing them compared to the need to leave open positions overnight.
Those who use swing trading strategies are usually focused on possible short-term price movements and choose assets, the price of which can significantly increase or decrease shortly. These traders work with a certain trend and try to find fluctuations within that trend. They do not necessarily close positions on the same day, it all depends on how long the trend continues. In some situations, they may keep positions open for weeks or even months.
Using the scalping strategy, traders seek to make as many trades as possible during the day. They do not wait until the price movement in the right direction provides them with the maximum profit. Instead, they fix even the minimum profit. In some cases, they hold a position open for just a few seconds. The main goal of these traders is to obtain even a minimum but frequent profit.
How to trade CFDs – CFD Trading Steps
Chaotic trading with any instrument will never bring you good results, and in the case of CFDs, this rule is even more true. So how to succeed? Follow clear steps in CFD trading:
- Decide which market you will be trading. Think about whether you will trade only CFDs or whether you will also focus on other assets.
- Decide, act. You can plan and speculate whether the price will rise or fall for a long time, but the only real result you will achieve is when you hit “buy” or “sell”.
- Decide on the volume of your transaction. Think about how many CFDs you are planning to buy or sell. Do not forget about money management and trading discipline.
- Keep track of your losses and do not neglect stop orders. Not every trader uses a stop loss in their work, but this tactic is wrong. When the market moves in the opposite direction to what the trader wants, a stop-loss is often able to prevent large losses. At least from time to time, track the price of the asset you bought, and if the price falls, try to close the trade on time.
Examples of CFD Trading
Let us consider several examples of CFD trading:
- You decide to buy shares of a company that is worth 40 dollars each. You have decided to buy 100 shares, in which case you would have to pay $4,000, including fees and commissions. When you work with a traditional broker, you must have at least 50% of your available funds in your account, which in our case is $2,000. A CFD broker will allow you to conduct such a transaction with as little as 5% of your account. You will only need $200 to be able to trade for $4,000.
- Let’s say the price of an asset did not go in a direction that was profitable for you, and you took a loss. When you trade with a CFD broker, with a 0.1 cent spread, it is enough for the stock to increase in value by 0.1 cents, and when you reach the break-even point. If you buy the stock directly, you can earn 0.1 cents, but your commission would be several times higher, not including the extra costs.
What Start-up Capital do I Need to Start a CFD Trading?
Every trader, who would like to trade CFDs, has a quite logical question: “How much money do I need to have in my account to start trading? This is where one of the benefits of CFD trading comes into play, in that by opening an account with a regulated broker, you can trade with the leverage of any asset in the CFD.
This includes not only stocks but also commodities, precious metals, cryptocurrencies, currency pairs, and much more. Thus, the minimum deposit will directly depend on the broker chosen, but, in most cases, it will be enough only 100 dollars, and in some cases, this sum doesn’t exceed 500 dollars.
Moreover, many brokers, such as Exness, always have an opportunity to start trading with a demo account. With a demo account, you can gain experience in trading, but you also do not risk your money, which is very important, especially for beginners.
Advantages of CFDs
Let us now look at some of the advantages that a trader will gain by choosing a CFD:
- Greater leverage – As compared to regular trading, CFDs allow you to use more leverage. Nowadays, a trader can use 2:1 leverage in the CFD market, but it is crucial to understand that higher leverage means higher risks.
- An opportunity to trade not only CFDs but also other assets – If you choose Exness broker, you’ll have access to all markets, not only CFDs, and you’ll be able to do it in the most favorable conditions. You do not have to be bound to a specific time frame, but you can trade the financial markets whenever it suits you, making decisions on all assets from one trading platform, which is fast, easy, and convenient.
- Access to all the tools you need – When trading CFDs, the trader can use absolutely all of the orders, stops, and other tools he needs, just as he would with a traditional broker. If the broker offers a guaranteed stop, he may or may not charge for such service. In any case, in the future, these costs will be reimbursed to the trader.
- No restrictions on day trading – When trading traditional financial instruments, some brokers introduce certain restrictions, for example, on the number of transactions concluded by the trader or limits on the transaction amount. All this negatively affects the trade and often does not allow the trader to implement his strategy.
The CFD market does not have these restrictions at all, and account holders can open deals at any time of the day when they want without thinking about any limitations. The account may be opened for absolutely any amount, as long as it is not less than the minimum required amount.
Risk hedging and other facilities
CFD traders can always hedge their risk by buying other instruments, such as commodities, stock indices, Treasury bonds, or currencies. In addition, including different types of assets in one’s investment portfolio allows you to count on higher profits.
Disadvantages of CFDs
Apart from the advantages of CFDs, they also have some disadvantages:
- Lack of ability to take small movements because of the spread. When opening a deal and leaving it, a trader will have to pay the spread, which makes it unprofitable to make small deals and take the minimum price movements. In addition, the need to pay the spread reduces the profit earned by the trader.
- The sector is practically unregulated. Because the CFD industry is unregulated, it provides access to the market for less than honest brokers. Therefore, traders have to choose a CFD broker based on the length of his work and reputation and the reviews of the clients. However, choosing an Exness broker will solve this problem. You will receive all necessary tools for successful trading and the best financial conditions for work.
- High risks. No matter what assets you choose to trade, there is always a risk. The problem with CFDs is that many traders do not well understand them, and many traders want to start trading them as soon as possible and end up losing money.
CFD Regulation by Countries
As we have already noticed above, this sector is relatively poorly regulated. For example, in the United States, you cannot trade these contracts because they are illegal. However, in most OTC and quoted markets in most countries, these contracts are available. In particular, they can be traded in Italy, Spain, France, Germany, Norway, Belgium, Thailand, Sweden, Denmark, Canada, Switzerland, and other countries.
However, it is worth noting that some countries are reviewing their attitude to CFD. Particularly in Australia, where these contracts were banned not so long ago. Today the Australian Securities and Investments Commission is considering the release of these contracts and their distribution to retail investors. Even in the U.S. trading in such contracts is available to non-residents.
What is a CFD in Trading?
CFDs are contracts that investors and financial institutions enter into with each other. An investor takes a specific position on the future value of an asset. There is no physical delivery of the asset, but the broker and the client essentially exchange the difference between the opening and closing price.
Is Trading CFDs a Good Idea?
It is no doubt that CFD trading can provide investors with significant advantages, particularly the possibility to use higher leverage, hedge their risks, and trade several instruments at a time. However, it is essential to understand that CFDs will be a good trading idea only if traders are prepared for all the risks and are willing to learn all the peculiarities of trading this instrument.
Why is CFD illegal?
CFDs are over-the-counter assets and may not be traded on some regulated exchanges. However, you can always use Exness brokerage services to trade CFDs and a wide range of other instruments freely, increasing your chances of profit.
How Are CFDs Taxed?
When choosing a CFD, you will anyway pay Capital Gains Tax on profits. As for stamp duty, in countries such as Ireland and the UK, you will not have to pay it since you are not essentially receiving a physical asset.
What Makes a CFD Trader Successful?
To be successful, a trader must constantly study the basics of technical analysis, be able to predict the movement of prices on the market, have a good sense of trading, and always observe trading discipline. It is also desirable to follow the news of this sphere enhancing knowledge.