What are CFDs?
Contracts for Difference (CFD) are leveraged products that provide a cost efficient way to trade thousands of markets worldwide in an extremely flexible way.
One of the main benefits of CFDs is that you can trade on margin, meaning that you only need a fraction of the normal cost it would take to own the underlying asset.
They are a flexible alternative to traditional trading, but they are also leveraged products so never forget that losses can exceed your deposits.
If you want to know more about CFDs, Investopedia has a complete article.
What markets can you trade ?
CFD are derivatives that enable you to trade the price movements (long or short) of many assets (stocks, forex, commodities, bonds, bitcoin, …) without ever having to buy these assets.
What is leverage, or margin?
Leverage (or margin) is the ability, when you want to trade an asset, to only deposit a fraction of the cost of that asset on your account.
By allowing you to trade positions without requiring you to mobilize the capital they would theoretically require, CFDs enable you to boost your returns, but it will also magnify your losses.
The idea is that returns or losses will be based on the full value of a position while you will only have mobilized a fraction of it to open your trade.
How do CFD’s work ?
With CFDs you will buy or sell a number of units for the particular asset you have decided to trade, depending on whether you think price will go up or down.
For every point variation of that asset, your gains (or losses) will be multiplied due to leverage.
Trading CFDs usually has several cost components:
- Spread: difference between the buy and sell price
- For shares, commissions on every buy / sell operation
- Holding costs : your broker will charge (or credit) your account with overnight holding costs
Example of a CFD trade
- First, choose an asset offered as a CFD by your broker, let’s say an AAPL CFD. It doesn’t have to be a stock, it could also be an index, a currency or any other asset that your broker offers.
- You open the position (let’s say you buy 2 AAPL CFDs) by setting the parameters, choosing whether you’re long or short, using leverage, defining the invested amount, and other parameters depending on your broker.
- You will not have to put up the full price of 2 AAPL stocks because that will depend on the CFD price, usually CFD will offer leverage, trading with lower capital requirements but consequently a higher level of risk.
- With this transaction, you engage in a contract with the broker, agreeing what the opening price for the position is, and whether or not additional fees (such as overnight fees) are involved.
- The AAPL position is opened and remains open until either you decide to close it or it is closed by an automatic Stop Loss or Take Profit, or contract expiration.
- If your position closes in profit (the AAPL stock has risen), the broker pays you. If it closes at a loss, the broker charges you for the difference.
Where can you trade CFDs ?
There are a good number of Brokers proposing CFDs.
Thee best know are :
- IG Markets: the world’s leading CFD provider
- CMC Markets: a very reputed platform
- eToro : with interesting social trading functionalities, you just copy the best traders
- Avatrade: available in 6 jurisdictions
Their websites contain a lot of free educative material, you can easily learn the basics of CFD trading there.
Well, that’s it for a short introduction to CFDs, a powerful trading tool that needs to be used with great care but can produce outsized returns.
If you have any question regarding CFDs, you can drop them in the comment box below.