Trading Guide

So, what are CFDs? A Contract for Difference (CFD) represents an agreement between two parties to exchange the difference in the value of an asset from the time at which the contract is opened, to when it is closed. 

To better understand how to trade CFDs, a good place to start is by looking at traditional investing.

If you wanted to invest in a public company, you may choose to buy shares in that company. Similarly, if you wanted to invest in gold or oil, you could buy a bar of gold or a barrel of oil. Then you would wait for the price of your shares, gold or oil to hopefully increase, enabling you to sell the asset at a higher price and thus make a profit. 

CFD trading works in a similar way – you open a trade on an asset at a certain price, wait for the price to either increase or decrease and then close the trade for a profit or loss on the difference. 

One of the biggest differences between trading CFDs and traditional investing is that, with Contracts for Difference, you never take ownership of the underlying asset. Instead, a CFD mirrors the price of the underlying asset and, rather than buying that asset, you merely speculate on how its price might change.

How Do CFDs Work? 

To answer this question, it is best to look at an example. Let us say you wanted to trade CFDs on gold.

If you believed the price of gold might rise, you could open a buy, or long, trade in your CFD trading platform. If you opened the CFD trade when gold was priced at $1,500, and then closed the trade when gold hit $1,525, you would make a profit of $25 (not accounting for any trading costs). 

On the other hand, if you thought the price of gold was going to fall, you could open a sell, or short, trade in your CFD trading platform. If you opened the CFD trade when gold was priced at $1,500, and then closed the trade at $1,450, you would make a profit of $50 (again, not accounting for any applicable costs of trading).

Trade on a Risk-Free Demo Account

A demo account from Admirals is the perfect place for a beginner trader to learn how to trade CFDs or for an experienced trader to perfect their strategy! A demo account allows you to practice CFD trading in real-market conditions with virtual currency before risking your capital on the live markets. Click the banner below to open a free demo account today: 

What Are the Benefits of CFD Trading? 

Whilst there are plenty of CFD brokers who would be eager to provide you with a long list of benefits, sometimes it can be hard to know what to believe – is everything that they are saying true or is it just another sales pitch? Keep reading for a balanced overview of the general benefits of CFD trading, after which we will look at some of the risks involved. 

CFD Leverage 

One of the biggest benefits of CFD trading is the use of leverage. CFD leverage allows you to access a larger portion of the market with a smaller deposit.

The amount of CFD leverage you will have access to depends on the instrument you are trading, your local regulator and your broker. For professional traders, you may be able to obtain leverage of up to 1:500. For retail traders, some instruments will allow leverage of up to 1:30. 

So, if you have $1,000 in your account balance, and available leverage of 1:30, you can access $30 for every $1 in your account.

This means that, with a relatively small deposit, you can still make the same profits (and losses) you would make in traditional investing. The difference is that the return on your initial investment is much higher. However, CFD leverage must be used with caution, as potential losses are magnified to the same extent as potential profits.

Trade Long and Short 

One of the downsides of traditional investing is that you only make a profit when the markets are going up. However, trading CFDs allow you to trade both long and short, meaning you can profit in both rising and falling markets.

If a trader thinks the price of an asset will increase, They may choose to 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.

 In a long CFD trade, the trader thinks that the value of an asset will increase. Therefore, they open a ‘buy’ trade at a lower price and then, hopefully, sell (or close the trade) at a higher price for a profit. If the market turns and the price decreases, however, the result will be a loss. 

In a short CFD trade, the trader thinks an asset’s price will decrease. Therefore, the trader opens a ‘sell’ trade, and will close it at a lower price, making a profit on the difference. Like in a long trade, if the asset’s price moves in the opposite direction to what you expected, the trade would end in a loss. With the ability to trade both long and short, Contracts for Difference allow traders to find opportunities in any market. 

Wide Range of Tradable Markets 

Because CFDs are derivatives of other assets, they can be created to represent virtually any market. In fact, many CFD brokers (like Admirals) give traders access to thousands of financial markets through a single CFD trading platform.

Just some of the markets available for CFD trading include:

• Forex
• Shares
• Commodities
• Exchange-Traded Funds (ETFs)
• Stock Indices
• Bonds
• 
  

Trading Hours 

As we have already covered, CFDs reflect the prices of an underlying asset; they also reflect the trading hours of those assets. During the week, there is always something available to trade, no matter what the time of day is.

Here are the trading hours for some popular CFDs: 

• Forex CFDs: 24 hours a day, 5 days a week 
• Index CFDs: 24 hours a day, 5 days a week 
• Share CFDs: Available for trading during the hours of the relevant stock exchange 
• Commodity CFDs: 24 hours a day, 5 days a week 

Across a week as a whole, trading is available on Forex, commodities and indices from midnight on Sunday evening until 11 pm on Friday (London time).

Expiration Dates 

Another benefit of CFD trading, is that most trades do not have expiration dates, meaning that traders can close their positions whenever they wish. The benefit of this is that traders have the option of making long-term trades without worrying about them being closed before you are ready due to hitting an expiration date. However, there are times when a trade may be closed on your behalf, such as, for example, if there are not enough funds left in your account. There are also some exceptions, such as CFDs on commodity futures, which do have an expiration date.

Costs of Trading 

Finally, the cost of trading CFDs is often lower than other forms of investments. We have already discussed traditional investments, where you need to pay the full value of the asset to invest. With lower margin requirements, CFDs have a lower cost of entry. CFD brokers earn the majority of their income on what is known as the ‘spread’. If you look at any instrument in your CFD trading platform, you will see there are two prices quoted – one to buy and another to sell. These are known as the bid (buy) and ask (sell) prices and the difference between them is the spread. Therefore, when you open a trade, the price of the asset needs to cross the spread before the trade becomes profitable. The spread itself goes to the broker. Some CFD brokers might also charge commission charges.

Additionally, if you keep a CFD trade open overnight, you will be charged an interest fee, known as the ‘swap’. You can calculate the fees on a potential trade by using our free CFD trading calculator.

Tax may also be something to consider but will vary depending on your individual circumstance and geographical location. For example, in the UK, traders may have to pay Capital Gains Tax (CGT), however, no stamp duty is payable. It is always best to consult a tax specialist for further details if you are unsure of your obligations.

What Are the CFD Trading Risks?

As with any method of trading or investing, there are risks involved in CFD trading. Contracts for Difference are complex products, which carry a high level of risk, so it is important to do your research thoroughly before you start using them.  The primary risk of any type of trading is market risk. If the market moves in the direction you traded, you will make money; but if it moves against you, you will lose money. However, because CFDs are traded using leverage, these losses can be more extreme when compared to your initial investment. Consequently, it is crucial to always use leverage with extreme caution and make sure you have a risk management strategy in place.

In volatile markets, this could lead to your balance dropping below 0, known as a negative account balance. With this in mind, it is very important to choose a CFD broker that offers a negative balance protection policy