CFD Trading for Beginners
Contracts for Difference, or CFDs, are a type of financial derivative product which can be used to speculate on the price of an asset. Whilst trading CFDs is readily accessible online, they are a complicated instrument and it is important for beginners to educate themselves on how they work before getting started.
In this article, we examine CFD trading for beginners, highlight some of the benefits of CFD trading, as well as the risks, and demonstrate how to trade CFDs online.
Table of Contents
What Is CFD Trading?
A Contract for Difference (CFD) represents an agreement between two parties to exchange the difference in an asset’s price from the time at which the contract is opened, to when it is closed.
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 asset’s price and, rather than buying or selling the physical asset, traders use CFDs to speculate on how they believe its price will change.
CFD Trading Example
To better understand how CFD trading works, it is best to look at an example. Let’s say you wanted to speculate on the price of gold by trading CFDs.
If you believed that the price of gold was going to increase, you could open a buy, or long, trade using a CFD trading account. Let’s say you bought one contract of gold when the price was $2,000 and it subsequently rose to $2,100, at which point you closed your trade.
In this scenario, you would have made a $100 profit (not accounting for any trading costs). Of course, if the price had fallen, then your trade would have lost money.
Why Trade CFDs?
There are a number of benefits associated with trading CFDs, and a number of drawbacks as well, which we will come to in due course. Some of the main advantages of CFD trading are highlighted in the table below.
Leverage
One of the biggest benefits of CFD trading is leverage, which allows you to access a larger position size with a smaller deposit, known as a margin.
The amount of CFD leverage you will have access to depends on the instrument you are trading, your location and your broker. For example, at Admiral Markets, UK-based retail traders can access CFD leverage of up to a maximum 1:30.
A leverage ratio of 1:30 essentially means that, for every $1 in your account, you can access a position worth $30. So, if you had leverage of 1:30 and wanted to open a position worth $1,500, you would need a margin of $50.
Whilst this means that trading CFDs on leverage will magnify potential profits, it also means that is has the exact same magnifying effect on losses.
Trade Long and Short
One of the downsides of traditional investing is that, unless you already own an asset, retail clients can typically only make a profit when markets are going up.
However, trading CFDs allows you to trade both long and short, meaning you can attempt to profit from both rising and falling prices.
If a trader thinks the price of an asset will increase, they can open a buy, or long, trade, in the hope that they will be able to close the trade at a higher price for a profit. On the other hand, if a trader thinks an asset’s price will decrease, they can choose to enter a sell, or short, trade, in the hope they will be able to close the trade at a lower price for a profit.
Speculate Without Receiving or Delivering Underlying Asset
We touched on this in the last section, but it’s worth highlighting as a separate benefit of CFD trading.
Contracts for Difference, and other financial derivative products, allow traders to speculate on an asset’s price without ever having to take possession of, or deliver, the underlying asset.
When it comes to tangible assets such as commodities, this is particularly advantageous. Of course, traders could speculate on the price of a commodity, such as oil, by buying and selling the physical commodity. However, this would present a whole host of logistical issues, such as transport and storage, which would make this approach impractical.
CFD trading, however, eliminates many of these logistical issues. Nevertheless, there are still costs to bear in mind, which we will cover shortly.
Hedging
CFDs can be used to hedge other open trades or investments which you may hold elsewhere in your portfolio. Hedging is an attempt to mitigate risk in a market position by entering into an opposing position in the market.
Consequently, if the main position falls in value, this loss will be offset by gains in the opposing position.
For example, let’s say an investor owns shares in Apple but believed that the company’s share price was about to fall. Instead of selling their shares, which would incur transaction costs and potentially capital gains tax, the investor may choose to hedge their position instead, by short selling Apple stock CFDs.
If the investor is correct, and Apple’s share price falls, then the loss in value on their main position will be compensated by the gain made from their short position.
Wide Range of Tradable Markets
Because CFDs are derivatives of other assets, they can be created to represent many different markets. In fact, many CFD brokers, including Admiral Markets, give traders access to thousands of financial markets through a single CFD trading platform.
Some of the markets available for CFD trading include:
- Forex
- Shares
- Commodities
- Exchange-Traded Funds (ETFs)
- Stock Indices
- Bonds
Risks of Trading CFDs
We have analysed some of the main benefits of CFD trading but it’s also important to highlight the risks of trading CFDs. All trading and investing is risky but there are specific CFD trading risks to be aware of.
Paradoxically, one of CFDs greatest benefits also happens to be one of its greatest risks - leverage.
As with any method of trading and investing, the primary risk faced by market participants is the very real risk that the market will move against them, resulting in the loss of money. However, because CFDs are traded using leverage, these losses can be more extreme when compared to your initial investment.
Yes, leverage will amplify potential profits on successful trades, but it will have exactly the same amplifying effect on losses. Consequently, it is crucial to always use leverage with extreme caution and make sure you have a risk management strategy in place.
CFDs are complex products and it is important to research them and their associated risks thoroughly before getting started. Practising on a CFD demo account can also be a good way of preparing yourself to manage the risks of trading CFDs on the live markets.
CFD Trading Costs
When it comes to CFD trading costs, there are several possible fees that traders should be aware of. In the following sections, we will take a quick look at three common CFD costs. Please note that our list does not include tax obligations, which may have to be paid on profits depending on your location and individual circumstances.
Commissions
Often, brokers do not charge commissions for commodity and Forex CFD trading, although this will of course depend on the CFD broker in question.
However, many brokers will charge a commission for opening and closing CFD trades on stocks and Exchange-Traded Funds (ETFs). For example, with the Trade.MT5 account from Admiral Markets, commissions on share and ETF transactions start from $0.02 per share.
The Spread
CFD brokers earn much of their income from the spread, which is the difference between the buy and sell prices of an asset.
The buy, or bid, price will always be slightly higher than the sell, or ask, price. This means that whenever you open a CFD trade, it needs to cross the spread before it becomes profitable.
The Swap
If you hold a CFD trade open overnight, you will be charged an interest fee known as the swap. This interest fee is a result of trading on leverage and is charged because, when you trade on leverage, you are essentially borrowing funds in order to finance your position.
If you want more detail about potential CFD trading costs for a specific trade, you can calculate the fees using our free CFD trading calculator.
How to Trade CFDs
Now that we have covered the basics of CFD trading for beginners, you might be wondering how to trade CFDs online. There are a few steps involved, but we have broken it down into a simple guide to help you on your way! Learn how to start trading CFDs by following these three steps.
1) Create a Trading Account
Firstly, you need to choose a CFD broker to open an account with. This could be a live account, where you deposit money and use that to trade on the financial markets, or it could be a demo account, which allows you to get to know the software and practice your skills with virtual currency.
2) Download a CFD Trading Platform
Picking the best CFD trading platform is something to consider when trading CFDs online and also when picking a broker.
Admiral Markets uses two of the most popular platforms in the trading world, MetaTrader 4 and MetaTrader 5, which are designed specifically for trading both CFDs and Forex. We also offer the MetaTrader WebTrader, which allows traders to trade CFDs online directly from their web browser!
3) Make Your First Trade!
The final step in learning how to trade CFDs is making your first trade on a live or demo account. Just follow these steps:
- Open a Trade.MT4 or Trade.MT5 account with Admiral Markets.
- Log in to the Dashboard.
- Open the MetaTrader web terminal.
- Search for the CFD you want to trade and click the symbol to open a price chart.
- Choose your position size and click buy or sell depending on what you think will happen with the asset’s price.
Trade CFDs With Admiral Markets
If you are feeling ready to start trading CFDs, the Trade.MT5 account from Admiral Markets may be the perfect place for you! A Trade.MT5 account allows you to trade CFDs on Forex, commodities, shares, ETFs, stock indices and more! In order to open an account and start trading CFDs, click the banner below:
FAQ - Trading CFDs
How much money do I need to trade CFDs?
In order to start trading CFDs, you will need to meet your broker’s minimum deposit requirement. At Admiral Markets, our minimum deposit will depend on the type of account you wish to open and your location. 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 of CFD trading include:
- The ability to trade long and short without taking ownership of or delivering the underlying asset.
- Access to leverage.
- A wide variety of tradable markets.
How long can you keep a CFD open?
The vast majority of CFDs do not have expiration dates, the only exception being CFDs which track futures contracts. Consequently, a CFD trade can, in theory, be kept open indefinitely, subject to minimum margin requirements being met. However, it is important to remember that CFDs which are left open overnight are subject to swap fees, which can add up over time.
Is CFD trading easy?
No. Not only are Contracts for Difference complex instruments, but trading with them is also accompanied by a high level of risk. Before trading CFDs, you must educate yourself on how they work, ensure you are aware of the risks involved and take precautions in order to minimise these risks where possible.
Is CFD trading legal in UK?
Yes, CFD trading is legal in the UK. However, CFD leverage for retail traders is restricted to a maximum of 1:30.
How are CFDs taxed in the UK?
Whilst not liable to stamp duty, traders may have to pay capital gains tax on profit made from CFD trading. To find out more about your specific obligations, check with HM Revenue and Customs or speak to a tax specialist.
Why are CFDs banned in the US?
The US Securities and Exchange Commission (SEC) prohibits US citizens from opening and trading on CFD accounts. This is partly due to the fact that CFDs are an over the counter (OTC) product, meaning that they are not traded through a regulated, centralised exchange.
About Admiral Markets
Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
