CFDs or Contracts for Difference are financial instruments for online trading. They allow you to take advantage of changes in the price of an underlying financial asset, such as shares, currencies or commodity exchanges.
In the first lesson of our full CFD course we will see what CFDs are and how to do CFD trading.
For example, by trading Apple CFDs, we get results based on the variation of the Apple value as quoted on the stock exchange.
Therefore, CFD trading is a practice that allows you to forecast the development of financial markets.
CFD what is it?
With CFDs, a great opportunity has opened up for those who, despite not being professionals in the sector or not having large amounts of capital, through an online trading platform and an Internet connection, can exploit their knowledge and skills to invest in upside or downside based on their own market forecast.
In this article we will highlight:
- The main advantages of CFDs
- The difference with stocks
- The financial products on which they allow trading
- The best platforms for trading with free demo.
How does CFD trading work?
How does the negotiation of this instrument work technically?
CFD trading is between individual investors and the companies that offer this service (brokerage firms), and there are no standard contracts for CFDs. Therefore, the companies can stipulate their own contracts, but they will have some points in common like:
- The contract for difference begins when the user (the investor) opens a rising or falling position in a certain instrument, and ends when he closes it
- The investor’s profit or loss will be proportional to the price variation that occurs between the opening and closing of the position
- As remuneration for his service, the broker will normally apply a spread between the bid and offer price at opening. In addition, they can add commissions for extra services (Overnight, night financial service fee) and in some rare cases also an extra cost if you manage your portfolio
- At the daily market close, a position can be left open until the next day
- CFDs are products traded on margin. This means that the trader must always maintain the minimum margin level.
- If the amount of money deposited in the CFD platform falls below the minimum margin level, the broker will perform a margin call, to ask the trader to deposit funds to quickly cover these margins, because otherwise the broker will close the open positions needed to protect himself.
CFD Trading Platforms
To make CFD trading you need a program that allows you to access the market and place orders both upward and downward. These programs are commonly called CFD trading platforms, and you can register for free. CFD trading can be done with programs and applications, or also from the broker’s own website.
Compatible systems depend on the program offered by the broker. Therefore, below we will specify which operating systems are compatible with the various platforms mentioned. Those who do not have much experience and prefer an easy platform to use will find some very simple programs.
On the other hand, those who already have experience with technical analysis applied to trading will find the use of more professional platforms very satisfactory. A very famous and used one is MetaTrader 4, of which we have published an introductory course that explains in detail all its functions with this program, such as the demo function.
Read also: MetaTrader 4 course with free demo
Costs of CFD Trading
The aspect of costs can be included among the advantages because trading with CFDs requires much lower amounts compared to traditional trading. Also regarding the spread (the broker’s profit for his service), these are very low percentages especially compared to the commissions that most banks ask for.
In fact, instead of earning from commissions, online CFD brokers earn from opening positions through the spread, therefore the more positions are opened, the more the broker earns.
Therefore, with CFD trading there is no conflict of interest because the broker does not make a profit from the trader’s loss, but from the amount of his operations, each of which allows the broker to retain a small percentage that will depend on the type of instrument traded.
You can open an account with a minimum deposit of only $10 with the IQ Option broker. Start with the demo here.Advantages of using CFDs
CFD trading has many advantages, which can be summarized as economical, practical and fast compared to traditional trading. With CFDs you can trade online from your computer, smart phone or tablet. There is less paperwork involved than with traditional trading.
For example, you don’t need to own paper securities, deposited in the bank and negotiable only upon consultation and request. CFDs can be traded with one click and open positions can also be closed within minutes (or seconds). Therefore, you can take advantage of gains of a few minutes’ duration, which can be closed at a profit.
Another great advantage is that with CFD trading you can profit from falling prices. For this you do not need to buy first and then sell, but simply open “Sell” positions. Check out the best platforms for CFD trading here
Other advantages can be seen mostly by directly comparing CFDs and Stocks as shown below.
Another big difference between CFDs and Stocks is the financial leverage. CFDs are instruments that are subject to leverage, per trade. The user will not be exposed for the total amount of the value of the shares traded, but only for a smaller percentage. We will explain this concept later.
Which assets to trade CFDs?
Through CFDs it is possible to trade many financial instruments among which:
- Forex
- Commodities
- Stocks
- ETF
- Crypto-Currencies
Forex CFDs
Forex CFDs allow you to trade in the foreign exchange market, opening up upward or downward positions in currency pairs such as EUR/USD, USD/JPY, etc. The benefits of Forex trading with CFDs include the high leverage offered by the broker (approximately 1:200) and the more advantageous spread compared to other financial instruments. You can trade forex with IQ Option here.
The lower the spread (the difference between the buy and sell price of the CFD), the more convenient it will be to open a position with a financial instrument. As far as Forex CFD trading is concerned, it is also worth mentioning that the famous professional trading platform MetaTrader 4 is perfect for this type of financial instrument, although it is more difficult to use than others.
Read also: What is the spread?
Commodity CFDs
Commodity CFDs allow trading of oil, gold, silver, etc., and other assets, such as food (soy, coffee, sugar, cotton, etc.). Also for commodities (raw materials) the financial leverage proposed by the broker is generally very high.
The prices of some commodities are very volatile. Therefore, we advise you to first make a study of the commodity you want to trade before investing.
You can open a demo account and trade commodities with IQ Option here.Stock CFDs
Unlike stocks, you do not need to own any securities to trade CFDs. Therefore, there are also not as many formalities and costs of a traditional stock investment like management fees.
Although CFDs will not be materially owned, we can easily trade them in a short time. However, most CFDs do not have an expiry date, so we can keep a position open as long as you wish. Obviously you will have to pay Overnight costs, i.e. the small amounts to the broker in exchange for holding the position overnight (3 nights on the weekend).
It is important to emphasize that CFDs are instruments designed to obtain results in a short time, buying in a rising or falling market, in order to take profit from the upward or downward variation of a stock. Unlike stocks, CFD positions can be closed within minutes, with a simple click.
ETF CFDs
ETFs or Exchange Traded Fund type are private funds with shares that are traded like stocks, and are characterized by high liquidity and low management costs. CFDs allow you to invest in these instruments up and down easily and with a good variety of funds.
Crypto-Currency CFDs
CFDs also offer the possibility of trading the major cryptosystems by taking advantage of the frequent price movements of these important assets.
Details about CFD Trading
Let’s look at the details about CFDs and the basic features that should be considered. When we launch a CFD trading platform, we will always have access to individual product details.
In this example, we will examine the details of the CFD on Amazon stocks. You can best follow this example by downloading the free IQ Option platform from here.
Read our article: How to buy Amazon stocks?
For example, there are brokers who apply maximum leverage to a particular financial product. So, for example, you could provide a maximum leverage of 1:50 for stocks and a maximum leverage of 1:100 for currency pairs.
Now let’s examine these features point by point.
Unit amount
The unit amount of the shares represents the basic amount of the financial instrument that can be traded. In practice, it is both the minimum tradeable share and the quantity of each unit. If I want to invest in Amazon I can do it with 10 shares, 20 shares, 30 shares, etc. Not with 35, for example.
The unit amount is also called the minimum lot, i.e. the minimum lot that can be purchased. If a share costs $10, the minimum negotiable amount is 10 shares so that is $100, which you can buy with leverage and invest $5 for a minimum lot. With CFD trading you can actually trade the stock with a few dollars, thanks to the leverage effect.
Financial leverage
For example, a 1:20 leverage allows $1,00 worth of stock to be traded with only $5. Margin and leverage rates may vary depending on the broker and the financial instrument used.
Finally, CFDs allow access to a wide range of stocks, something that is not normally possible to do through a traditional bank. And it is possible to create a portfolio of stock CFDs by choosing components from thousands of shares worldwide.
In addition to stocks, CFDs allow you to trade up and down on multiple financial instruments such as currencies, commodities, ETFs and various indices.
Margin
A very important aspect of CFDs is margin. We have talked about leverage and “margin”. Here is an example so that you can understand how they work.
First, let’s distinguish between these two types of margin in CFD trading:
Initial Margin
The initial margin represents the amount actually subtracted from the available account to open a position. For example, if we open a position on Popular Bank shares for $1,000, the initial margin is 5%, or $50, while for $500 it will be $25.
Maintenance Margin
The maintenance margin is a fee that the broker retains as a guarantee upon opening the position. In practice, it is a guarantee for the broker that offers the financial leverage and, therefore, the same broker assumes a risk on the part of the trader.
Let’s have an example. We open a position on $1,000 of the EUR/USD pair, with a leverage equal to 1:30. The initial margin will be equal to ($1,000/30) or $33.33. Of these, if the maintenance margin is 50%, $16.76 will be frozen. They will be returned to you when the deal is closed.
The maintenance margin is important because the capital (we will talk about it in the course) must always remain far enough away, in order to not reach the margin call (an alert warning the user that losses have reached a certain level)
We can say about margins that:
- When a position is opened, the variation in share price will influence the available capital
- When the decision is made to close the position, the sum of the margins, net of gains and losses, will be returned to you
Night Financing
This is a percentage that can be added to or subtracted from your account if you hold the position overnight. In practice, if you do not close the position before the market closes, with CFDs on Amazon shares, 0.03% is subtracted for buy positions held overnight. The weekend is counted as 3 days (Friday night, Saturday night and Sunday night).
In the case of sales it is a percentage that can be subtracted or added to your available account in case you keep an open position overnight. In this case, considering the details of the CFDs on Amazon stocks, in sales the premium is 0.01%.
Daily Expiration
Open CFD positions can expire daily, as well as remain open as long as you wish. In the case they expire daily, at expiration the difference between profit and loss is added to or subtracted from the available account. In the case of Amazon shares, for example, they do not expire.
Expiration Date
Some CFDs, when a date is scheduled, may expire not only at a specific time each day, but also on a specific date. In the case we are considering, there is no expiration date.
Time of Financing
The markets are not always open so each financial instrument can be traded only at certain times. When you leave a position open, you cannot close it if the market is closed, so you have to wait for it to open again.
In the example considered, CFDs on Amazon shares are tradable during Nasdaq opening hours. Over the weekend, the stock market remains closed around the world.
Regarding CFD trading hours, please note the following:
- Trading CFDs include indices and stocks from markets around the world, so the Asian markets will be opened on Sunday afternoon
- Remember that in addition to stocks you can also trade currencies. Among them, crypto currencies (Bitcoin and Litecoin) are always negotiable.
- The daily expiry time is not always at the market’s close, but it can work according to other logics, such as those of Forex, where some currencies (including virtual Litecoin) expire daily at 1.00.
To trade CFDs on Amazon shares as well as on other international shares, you can use the IQ Option platform for free, which besides stock certificates presents CFDs on Forex, Commodities, ETFs and indices.
All these instruments can be easily found on the CFD trading platform which you can download directly from here.
For more information on CFDs visit our section dedicated to CFD trading where we have included all the main instructions to start trading online with real and virtual money, taking advantage of the demo mode offered by the Brokers themselves.
Start practicing now, making money online will be the next step!
CFD Trading: Why and when to do it?
The practice of online CFD trading is especially suited to specific types of users. Understanding why and when to trade CFDs is the first step before embarking on this potentially profitable path.
However, it is not suitable for all types of people, for the following reasons:
- These are short-term trades, such as a few minutes, a few hours or a few days at most
- In the event of a negative result, the investment may be lost since these are operations with “risk” capital
- These are operations with high potential profit, in proportion to the amount deposited
- It is necessary to observe with interest the world of finance or at least the assets with which one wishes to negotiate
Short-term operations
One of the most fascinating aspects of online CFD trading is that high profits can be made briefly. Beware because it can also amplify losses. It will depend on the price changes after a position is opened. For example, if we open a position to buy Tesla or Apple shares and they get a percentage change of 1% within a few hours, at the same time my capital will increase accordingly.
We can open positions with Tesla or Apple shares and thousands of other securities. We also trade in currency pairs (such as Euro/Dollar), stock indices (e.g. US 30), and commodities (e.g. gold, oil, natural gas, etc.).
The speed with which a result is obtained is one of the main attractions of CFD trading.
However, this speed also demands more commitment, as we must be more attentive to open positions and ongoing trades. If we open a Long/Short position (up or down) on a particularly volatile security, we will need to pay attention to our trade so that we can close it as soon as there is a trade that we expect.
A very useful feature of trading platforms for this purpose is the Stop. The Stop function is divided into two types:
- Stop Loss: a function that allows you to set up an automatic close once a certain loss is reached
- Stop Limit: a function that allows you to set an automatic closure once a certain gain is reached
Venture Capital
The word “risk” should not scare us because every financial activity that has the objective of making money is characterized by a certain amount of risk. When we have the possibility of making a very high profit quickly we should also expect a high risk.
It is good to emphasize that CFD trading is a risky activity and it suits those who calculate the possibility of losing a certain amount in their budget . Of course, we could also win without losing (extreme optimism), as well as we could only lose without winning (extreme pessimism).
High Profit Potential
Indeed, although CFD trading allows you to start with a small amount like $100, you will not have the same results as investing $1000, $10,000 or more.
If I open a position with $50 and profit $10 net, I could have made $100 net using $500.
Let’s remember that the position can be closed whenever you want, so from when you are earning, you can keep the position open until you reach your goal. On the other hand, if a position is no longer profitable, we can close it whenever we want. This obviously has to be done during trading hours, which are equivalent to the actual trading hours of the underlying markets.
Financial news and more
In CFD trading, we need to keep an eye on the financial world, precisely because of the speed with which you can (and should!) take advantage of great opportunities. Of course, it is impossible to follow all the financial news in the world. Therefore, we give you this advice: consider few stocks at a time, depending on the period, perhaps keeping some of your “favorites”.
For example, the EUR/USD is a good asset to trade and offers good ideas based on so much news coming in daily. Another asset could be gold, or oil. In some periods, trading on US, European and Asian stock market indices is easier than it seems.
Getting ahead of the financial news is a practice that can be performed daily. To begin with, you only need two things:
- A free trading platform, from a recognized broker like eToro
- A portfolio of sites for updated information (e.g. “Yahoo! Finance”, etc.)
Frequently Asked Questions
What are CFDs in trading?
CFD’s are financial instruments through which you can trade forex, stocks, cryptosystems and more.
How does CFD trading work?
You can open a position upwards or downwards according to your own analysis.
How do stock CFDs work?
CFDs replicate the price of a stock and allow you to trade them using less money through leverage.
Which platform do I use to trade CFDs?
For beginners we recommend the IQ Option and eToro platforms. Simple and intuitive.
Go to Lesson 2 – Financial Leverage
From today, you can start trading CFDs through a demo account with this world leading platform, authorized by CYSEC
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