CFD Trading for Beginners
Contracts for Difference, or CFDs, are a type of financial derivative which can be used by traders to speculate on the price of assets. CFDs are a complex instrument and, for beginners, it’s important to learn how they work and to understand the risks involved before getting started.
In this article, we will examine CFD trading for beginners, highlight some of the benefits of trading CFDs as well as the risks involved, and examine how traders can get started.
The information in this article is provided for educational purposes only and does not constitute financial advice. Consult a financial advisor before making investment decisions.
What Is CFD Trading?
CFD trading allows traders to speculate on the price of an asset, such as gold or a company’s shares, without ever taking ownership of, or delivering, the underlying asset in question.
Instead, CFDs track the price of an underlying asset and, rather than buying or selling the physical asset, traders can use CFDs to speculate on how they believe its price will change.
CFD Trading Example
Let’s take a look at a CFD trading example to better understand how they work. CFDs can be traded on a range of markets, including stocks.
If a trader anticipated that Amazon shares were going to increase, they might choose to enter a long (buy) position using CFDs. When trading CFDs on stocks, one CFD contract is equal to one share of the underlying stock.
Let’s say our trader bought 100 share CFDs of Amazon stock when the price was $230 per share. The infographic below shows two possible scenarios, depending on which direction share price moves (fees are not accounted for).
Why Trade CFDs?
From the example in the previous section, you might be wondering, why wouldn't the trader just buy Amazon shares directly instead of using CFDs?
There are a number of reasons as to why a trader might choose to trade CFDs, some of which we have highlighted in the table below.
CFD Risks
Trading is inherently risky, with losses occurring when the market moves against you. However, this risk is somewhat amplified when trading CFDs.
Due to the magnifying effect of leverage, trading losses can be more extreme when compared to your initial deposit (margin). Consequently, traders face the risk of losing money rapidly due to leverage.
That’s why it’s crucial for traders to use leverage with caution and to take steps to manage risks when trading. For example, traders should consider using stop losses to help limit losses and should never risk too much on a trade.
CFDs are complex instruments and, before you consider using them, you should ensure you fully understand how they work and the risks involved. Practising on a demo account can also be an effective way of preparing yourself for managing risks in the live markets.
CFD Fees
As well as risks, traders should also be aware of the potential fees they may encounter when trading CFDs.
How to Trade CFDs
Now that we have covered the basics of CFD trading for beginners, let’s take a look at how traders can get started.
Learn the Basics
Before you get started, ensure you understand how what CFDs are, how they work, and the risks involved.
Open a CFD Account
When you’re ready, you’ll need to choose a CFD broker and open a trading account which provides access to CFDs. Depending on the broker you choose, you may also need to download a trading platform.
If you’re a beginner, it’s sensible to open a demo account first, so you can practise trading in realistic market conditions using virtual currency before risking your money in the live markets.
Choose a Market
CFDs can be traded on a range of different markets, choose which market and specific instrument you’re interested in trading.
Place a Trade
When you’re ready, and you’ve conducted your analysis, you might choose to take a long (buy) or short (sell) position in your chosen market, depending on which direction you think the market will move.
Naturally, the process for placing a trade will depend on which broker and platform you are using. With Admiral Markets, you can place a trade by following these steps:
- Log in to the Dashboard.
- Click ‘Trade’ next to your demo or live account details to open the Admiral Markets Platform.
- Search for the instrument you wish to trade and click the symbol to open its instrument page.
- Choose a position size and select stop loss and take profit levels.
- Click buy or sell depending on which way you want to trade.
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Frequently Asked Questions
How much money do you need to start CFD trading?
In order to start trading CFDs, you will need to meet your broker’s minimum deposit requirement to open a live trading account. To find out more, check out the Account Types page on our website.
What are the main benefits of CFD trading?
Some of the main benefits associated with CFD trading include: the ability to trade long and short, access to leverage, a wide variety of tradable markets, and the possibility of speculating on price without owning the underlying asset.
Does the use of leverage magnify the potential losses you can make on CFDs?
Yes. Whilst leverage can magnify potential gains on a winning trade, it will equally magnify losses on a losing trade. Consequently, it must be used with caution and in combination with a proper risk management strategy.
If the price of a stock rises what happens to CFD?
Stock CFDs track the share price of the underlying stock in question. Consequently, if a stock price rises and a trader is holding a long position using CFDs, their trade will profit. However, if a stock price rises and a trader has a short position, it would lead to a loss.
How long can you keep a CFD open?
Whilst CFDs are often used for short-term speculation, most CFD positions can technically be held open indefinitely, subject to margin requirements being met. The exception is CFDs on futures contracts which have expiration dates in line with the underlying contract. However, it’s important to remember that CFD positions are subject to overnight fees, which can add up over time.
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- The Analysis is prepared by an analyst (hereinafter “Author”). The Author Roberto Rivero is a contractor for Admiral Markets. This content is a marketing communication and does not constitute independent financial research.
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- Leveraged products (including contracts for difference) are speculative in nature and may result in losses or profit. Before you start trading, please ensure that you fully understand the risks involved.
