CFDs, or Contracts for Difference, are financial instruments that can be traded online allowing you to take advantage of price changes of an underlying financial asset, such as a stock, currency exchange, or commodity. For example, by trading on Apple CFDs, you get results based on changes in the listed Apple stock.
Therefore, trading with CFDs is a practice that allows you to make predictions on the performance of financial markets and profit from them in the event of a favorable outcome.
With CFDs a great opportunity has opened up for all those who, despite not being professionals in the sector or not having large capital, can exploit their knowledge and skills through an online trading platform to profit by focusing on increases or on rebates based on your market forecasts; and all of this can be done simply through an online trading platform and an internet connection.
In this article we will highlight the main advantages of CFDs, how they differ from stocks, the financial products on which they allow trading, and the best platforms to trade in (with free demos!)
Try a free demo and trade with a regulated and safe CFD trading platform.
Best CFD Trading Platforms
Below is a list of the best platforms for trading online with Cysec regulated CFDs in Europe:
|Broker||Features||Min. Deposit||Open account|
|100|| Open Demo|
||10|| Open Demo|
Advantages of trading with CFDs
Trading with CFDs has many advantages: inexpensiveness compared to traditional investments, practicality, convenience, and speed. With CFDs, you have the opportunity to trade online on your computer, smartphone, or tablet, with much less paperwork than traditional investments.
For example, there is no need to keep hard copies of securities in banks accessible for trading solely by consultation or request. CFDs can be traded in one click and open positions can be closed in a few minutes (or even seconds). You can also take advantage of stock price increases that only last a few minutes and then close the position thus making a profit.
Another big advantage is that with CFD trading, you can also profit from falling stock prices. In order to do so, you do not need to buy and then resell them, but simply open a short or “sale” position.
How CFD trading works
So far, we have seen how you are able to trade, what its advantages are, and which are the best platforms to trade on; but how does this kind of trading technically work?
CFD trading takes place between individual investors and the companies offering this service, i.e., brokerage companies or brokers. Since there are no standard contracts for CFDs, each company can determine its own, while adhering to some common rules, such as:
- The CFD starts when the user (the investor) opens an up or down position on a certain instrument and ends when they close the position on the same instrument
- The investor’s gain or loss will be proportional to the price change between the opening and closing of the position
- As compensation for their services, the broker usually applies a spread or a differential between the purchase and sale price upon opening. They can also add commissions for extra services, overnight (nightly financial service charge), and in some rare cases, even a managerial fee if it offers portfolio management services
- Once the market closes, a position is held and carried over to the following day
- CFDs are “margining” products and this means that the trader or the investor must always maintain the minimum margin level. In the event that the sum of money deposited on the CFD platform falls to a level lower than the minimum margin, the broker will make a margin call asking the trader to quickly cover these margins, which otherwise leads to the closing of positions by the broker in order to protect themselves
Margins of CFDs
A very important aspect to understand about CFDs is margin. We have already mentioned leverage and “margining”. Below we provide an example so that we can understand its operation in the best possible way.
First of all, we need to distinguish between the two types of margins present in CFD trading:
- Initial Margin: This is the amount that the user will actually trade, and is derived from the initial margin. It is calculated by calculating the ratio between nominal capital and leverage (e.g. if the nominal capital is $3,000 and the leverage is 1:30, the initial margin will be $100)
- Example: We buy 30 CFD Facebook shares for $100 each (“buy” position) and the initial margin is 10%. In this case the position value would be (30 * 100) * 10%, that is (3000) 10% or $300.
- Maintenance Margin: This is the margin that is required to keep the position open and that is returned when the position is closed.
- Example: Let’s say we open a €1,000 position on the EUR/USD, with leverage equal to 1:30. The initial margin will be equal to (€1,000/30) i.e. € 33.33. Of this, if the maintenance margin is 50%, € 16.76 will be frozen. These funds will be returned when the position is closed. The margin of maintenance is important because the equity (a kind of equity that we will discuss later in the course) must always remain far from it, in order not to run into a margin call, i.e. an alert warning the user that losses have reached alert levels.
Taking these two examples, to open a position of purchase on CFD shares on Facebook, I will have to subtract from the capital available in the trading account $300 + $150.
Regarding margins, it must be said that:
- Once the position is opened, the share’s price changes will affect available capital
- When you decide to close the position, you will get back the margin amounts netted of profits and losses.
Costs: How much does it take to operate with CFDs?
The question of costs can be included among the advantages because, as we have seen in detail, trading with CFDs requires much lower amounts than traditional investments. The spread is also very low and are in much smaller percentages compared to the commissions requested by most banks.
In fact, instead of earning commissions, online CFD brokers profit from opening positions by applying the spread, so the more positions they open, the more they gain.
With CFD trading, therefore, there is no conflict of interest as the broker does not profit from the investor’s loss, but rather from the amount of operations, each of which allows the broker to withhold a small percentage that will depend on the type of instrument traded. Usually, Forex offers the lowest spreads, which can be as low as 2 pips, as in the case of the Plus500 platform.
Do you need to be an expert to trade CFDs?
As in all sectors, the more you know a “territory” the better you move around it. So even if the practice of CFD trading is very simple, learning, keeping oneself updated and being committed can definitely help in obtaining increasingly satisfying results.
Ultimately, it is the financial market, so the more you follow it carefully, the more you will be able to take advantage of the different events to profit on price increases of the various stocks listed on the stock exchange.
Further advantages are evident by making a direct comparison between CFDs and stocks, as presented below.
What is the difference between CFDs and stocks?
Unlike with stocks, there is no securities ownership when trading with CFDs, therefore the many costs and paperwork related with a traditional stock investment, such as stamp duty or costs related to management, are non-existent.
Although CFDs are not securities that you physically possess, CFDs are for a short term purpose. Most CFDs do not expire, so you are free to keep your position open for as long as you want. You will have to meet overnight costs, or small percentage premiums that are due to the broker in exchange for maintaining your position overnight (3 nights on weekends).
It is important to highlight that CFDs are instruments designed to achieve results in a short time, buying in an up or down market, in order to profit from changes to the upside or downside of a stock. Unlike stocks, positions on CFDs can be closed even after a few minutes, with just a click of the mouse.
Another big difference between CFDs and shares lies in leverage. CFDs are leveraged instruments, so for each individual transaction, the user will not be exposed for the total amount of the value of the shares traded, but only for a small percentage.
CFDs are leveraged: what does it mean?
CFDs are leveraged instruments. But what does it mean, precisely? For example, a leverage of 1:20 allows you to trade on shares for a value of 1000 euro with only 50 euro. Margin rates and leverage may vary depending on the broker and the type of financial instrument used.
Finally, CFDs allow access to a wide range of stocks, which isn’t possible through a normal bank. It is possible to create a portfolio of equity CFDs by choosing the components among thousands of shares worldwide, listed on all major equity markets.
All you can trade with CFDs
In addition to stocks, CFDs allow you to trade on and off on multiple financial instruments such as currencies, commodities, ETF funds, and various types of indices.
CFD Trading on Forex
Forex CFDs allow you to trade in the currency market, then open long or short positions on currency pairs such as EUR/USD, USD/JPY, EUR/GBP, and many others. The advantages of Forex trading with CFDs includes high leverage offered by brokers and spreads, which are more advantageous than other financial instruments.
The lower the spread (the difference between the purchase and sale price of the CFD), the more convenient it is to open a position on a financial instrument. With regards to CFD trading on Forex, it should also be noted that the famous MetaTrader 4 professional trading platform is optimal for this type of financial instrument, even if it is more difficult to use than others (e.g., Plus500).
Read also: What is the spread?
CFD Trading on Commodities
CFDs on raw materials allow trading on oil, gold, silver, copper, natural gas, and other commodities, such as food (soy, coffee, sugar, cotton, etc.). The financial leverage offered by brokers are usually very high, even for raw materials. We recommend a preliminary study of the raw material before trading with real funds since the quotations of some raw materials can be very volatile.
CFD Trading on ETF
CFDs on ETFs have Exchange Traded Fund as their underlying funds. These are special funds whose securities are traded as shares and are characterized by high liquidity and low management costs. CFDs allow you to trade them up and down easily and with a good variety of funds.
CFD Trading on Indices
Index CFDs usually refer to the main stock market indices, such as the Dow Jones Industrial Index, the FTSE MIB, or the Frankfurt Stock Exchange, but also to Mid Cap indices, which contain equity securities of medium capitalization. Brokers also allow trading on other indices, such as the VIX index, or the volatility index, and others using the same methods.
CFD Trading on Options
Options CFDs are a new instrument that allow you to open positions on Call and Put options related to indices and other options. They are a relatively new financial tool and recommended for those who are just starting to trade on their own. As all the tools have advantages and disadvantages, we have created a binary options tutorial for those interested in furthering their knowledge on this topic.
CFD software, how to trade via apps and browsers
To trade CFDs you’ll need software that allows you to access the market and place orders. This software is commonly called a CFD trading platform and is usually offered for free by brokers to whom you subscribe to.
It should be specified that trading with CFDs is feasible with downloadable software, dedicated mobile trading apps, or even an internet browser. Compatible systems depend on the software offered by the broker, so we will specify which operating systems are compatible with the various platforms mentioned.
Those without much experience who prefer a simple-to-use platform will find some very intuitive software, whose features are easily used.
Those who have already gained experience with the technical analysis applied to trading will find the use of professional platforms more satisfying. One of the most famous platforms is MetaTrader 4. We have published an introductory course that explains all the features offered by this software in detail, as well as how to test it for free in demo mode.
Go to lesson 1b: CFDs details