What is CFD Trading and How Does it Work?
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Defining Contracts for Difference or CFDs
CFDs are a
contractual agreement between an
investor and a provider to trade the difference in value
between the open and closing price of a financial product. This way traders can earn a profit by
correctly speculating on whether the value of a financial product will rise or fall without taking
ownership of the underlying asset. It is a financial derivative product that allows traders to take both
a short and long position to profit from price movements in various financial markets such as forex,
shares, commodities and indices.
Although CFDs are more commonly used by experienced CFD traders, with the right support and risk
management, less experienced traders can also enjoy its benefits. The Regulators have also been
introducing rules and restrictions on CFDs (ESMA adopts final product intervention measures on CFDs and
binary options, 2018), aimed at making CFDs less risky which in turn will make it more accessible to
What is CFD Trading
Practically, CFD trading involves making an investment on whether a price will rise or fall, without
having the need to take ownership of the asset in question. What separates CFD trading from trading in
physical assets is the right to ownership and the ability to make short trades. When trading CFDs there
is no physical delivery of goods or securities. It is an agreement between the client and broker that if
the price moves in their favour they will earn a profit, and if not, they will suffer a loss.
The proceed of CFD Trading
A CFD trader gains profits when they enter and exit the CFD market at the right time. So, a CFD contract
is made up of two trades. The first trade is entering, or opening a position, in the CFD market. The
second trade is closing that position. Hence, if a CFD trader speculates that the underlying asset will
rise, they will buy the CFD. In this case the first trade is the buy or long position, and the second
trade is the sell or closing position. In contrast, if the trader predicts that the asset will drop in
value, they will sell or short the CFD. Here the first trade is the sell or short position, and the
closing trade is the buy.
The profit is calculated based on the difference between the opening and closing position. So, if a CFD
trader enters and exits a position at the wrong time then they will suffer a loss calculated again based
on the difference between the opening and closing position.
4. Assets You Can
One of the great things about CFDs is that they allow you to trade on the price movements of any
financial market like stocks, commodities, indices and currencies, without actually owning the
underlying asset. They can also be used to speculate price moves in the futures market.
You can apply CFDs across different assets that have drastically different values and volatilities. So,
it is crucial that when trading in CFDs, the investor needs to have a great understanding of the market
that they are engaging in.
Difference Between Short and Long CFD Trading
A traditional trade involves buying an asset in the hope that that asset will rise in value for which you
can then sell and earn a profit. This is known as going long. CFD trading also allows traders to earn a
profit when the asset drops in value, which is going short. The profit in both cases is calculated based
on the marginal difference between the opening position and closing position minus costs.
6. Pros and Cons of
There are various benefits of CFD trading. Some include:
Access to the underlying price movement at a smaller financial commitment:Because CFDs are
leveraged products, they allow investors to take up a much larger market position without needing to put
up the actual amount (this process is called ‘trading on the margin’). By trading on the margin, you are
able, but not obligated, to purchase more than what you normally would. This is known as the leverage
effect and is the main reason why investors like to choose CFDs, as it allows you to use your capital
Higher leverage:Trading on the margin typically provides higher leverage than what traditional
trading may offer. In the CFD market, a standard leverage can have a margin requirement as low as 3%. A
low margin requirement means less capital outlay needed and a greater potential return for the investor.
Keep in mind though with high reward also comes high risk and greater potential losses.
Access to a variety of global markets and indices:Investors can trade CFDs on a wide range of
worldwide markets. What you need to be mindful of is that CFDs are traded over the counter (OTC) by a
group of brokers that arrange the market demand and supply for CFDs and determine the price. Hence, CFDs
are tradeable contracts between a client and the broker but cannot be traded by major exchanges such as
the New York Stock Exchange (NYSE).
The transaction costs are very low: Compared to standard exchanges, CFDs can have fewer rules and
regulations that apply to them, which then allows for less capital or cash requirements to open an
account with a brokerage company. However, fewer regulations also means less accountability, so when
choosing to trade CFDs, traders should make sure to go through a trusted broker.
Flexibility to go long or go short:CFDs allow an investor to take a long or short position. This
means that they can invest and profit based on a speculation that the underlying asset value will go up
No day trading requirements: Prior to the development of online trading, the only people that were
able to trade actively in the stock market were those that worked for large financial institutions.
Restrictions were imposed on those institutions such as minimum capital requirements and trade
limitations. CFDs are not bound by those restrictions as all account holders can day trade as they wish.
The Costs of CFD Trading
Just like other forms of trades, CFD trading comes with its own costs. For instance, every CFD product
has a buy price and a sell price. The difference between them is called the spread. The size of the
spread varies depending on the market’s liquidity and volatility and can be the main costs associated
with CFD trading. The narrower the spread, the less price movement a trader needs to make a profit or
For those that hold positions for longer than a day, may be subject to a holding cost. This cost may be
positively or negatively geared depending on the direction of the position and the relevant holding
CFD trading also includes a commission cost per trade. This is a nominal percentage cost of the
underlying asset value that is paid every time a position is opened and closed. Which means that,
because CFD trading consists of two trades, when trading CFDs a trader will have to pay commission
Keep in mind, when trading CFDs on the margin, a trader will need to pay interest on the borrowed money.
The interest payment will depend on the position taken and the closing price. A long position bears the
cost of a base rate plus a nominal interest by the lender. However, when going short the interest is
paid back to the trader. The base rate is usually calculated by the interbank system.
Margin in CFD Trading
TWhen trading with CFDs a trader does not need to pay the full value of the position, but only a fraction
known as the margin. It allows them to take on more leverage, amplifying the potential profit scale, but
also potential loss.
So, let’s say that gold is trading at a bid offer quote of 2,000 US dollars and a broker is offering a
margin rate of 5%. If a trader believes that the value of gold will rise and choose to invest 1,000 US
dollars, they will be taking a marginal position worth 20,000 (because if 5% is 1,000 then 100% is
20,000). If then the value of gold rises to 2,200 US dollars, the trader will have earned 2,000 US
dollars minus fees if they choose to exit at that point.
Trading on the margin has its benefits as a trader does not need to take out a lot of their own capital
to take on a large position and enjoy the earnings that come with it. However, it does come with its
risks because if the trade does not go as planned, a trader may even receive a margin call which
requires paying extra to hold the position.
Leverage in CFD Trading
CFDs can be used to leverage a multitude of markets such as Forex, Stocks, Indices, Treasuries,
Commodities and Cryptocurrencies. The leverage in CFD trading is the level of amplified exposure traders
have above the marginal deposit provided as security (collateral). So, through CFDs, traders can take
large positions even up to 500 times their marginal deposit (described as a ratio of 1:500). But keep in
mind, with higher reward also comes higher risk, so amplified returns also means amplified losses.
Can You Trade CFDs without Leverage?
CFDs can be traded without leverage. In fact it might be a good idea, especially for beginners, to start
learning how to trade CFDs with a small position size rather than a large position size that also comes
with large position risks. This way a trader can familiarise themselves with CFDs whilst keeping their
risk to a minimum.
The fact that CFDs can be leveraged is one of the main reasons why traders use them in the first place.
For more experienced traders there might not be too much of a point in holding a CFD without leverage
because it is pretty much the same thing as holding a share.
11. How to use CFDs
Despite popular view, CFDs can also be great strategy tools for long term investors, especially since at
times the market has proven to be so unpredictable. With large financial declines taking place, it is
only reasonable to have strategies in place to protect or hedge. Hence, some reasons why long-term
investors would use CFDs as a hedging tool would be to:
Protect their position against adverse market price movements or profit from market downturns
through execution of short positions.
Have long term protection, as CFDs do not have an expiry date.
Minimise the cost of investment, because CFDs trade on the margin.
Mirror the market directly to know the relationship between the hedge and existing trade.
Easily alter their position size, to replicate existing trades.
Limit their risk in case the market doesn’t move as expected.
Key Points in CFD Trading: Spread and Commission, Lot Size and Duration
Spread: The spread is the difference between the purchase price (also known as the bid price) and
offer price (or sell price) at the time of the trade. So, when a trader wants to buy a CFD they pay the
offer price and when they want to sell they pay the bid price. Depending on the volatility of the
underlying asset, the spread may be small or large.
Commission: A CFD broker may charge a commission per trade. Be mindful that because a CFD trade
consists of two trades (the first when opening a position and the second when closing that position), a
CFD trader will need to pay the commission twice (round turn), once upon closing and once upon opening
Lot Size: A lot refers to a group of goods or services that form a transaction. They are usually
of the same class, model or version of a product and are made under the same circumstances and intended
to perform similar functions. It is the standardised quantity of a financial instrument such as a stock
or a bond that an exchange or regulatory body defines. The most common lot in forex trading is a
‘standard lot’ which represents 100,000 units of the base currency. A ‘mini lot’ represents 10,000 units
and a ‘micro lot’ represents 1,000 units. In forex trading for instance, one standard lot of EUR against
USD represents 100,000 units of EUR/USD.
Calculating Profit and Loss in CFD Trading
For argument’s sake let’s say Shares of Lloyds Banking Group Plc (LLOY) are currently trading at 51.615
with a buy price of 51.630 and a sell price of 51.600. In anticipation that the stock will increase in
value over the next few days, you decide to buy 150 share CFDs of LLOY at 51.630.
Then, say the Lloyds share price did climb and was trading at 52.615 with a new buy price of 52.630 and
sell price of 52.600. At this point you could close your position by selling 150 share CFDs of LLOY at
52.600. To then calculate your profit, you would calculate the difference between the closing price and
opening price of your trade and multiply it by its size. In this case, your profit would be £145.50
([52.600 – 51.630] x 150), excluding any additional costs.
However, if the Lloyds share price decreased to 50.515 (buy price 50.530 and sell price 50.500) and you
chose to close your position by selling the shares at that point of time, you would make a loss. To
calculate this loss you would have to first find the difference between the closing price and opening
price of your trade and then multiply it by its size. Hence, it would be a loss of £169.50 ([51.630 –
50.500] x 150 share CFDs), excluding any additional costs.
14. CFD Trading
Styles: Swing, Day, Scalp and Position
There isn’t necessarily a trading style that fits for all and the trading style you choose to follow may
depend on your own preferences, personality and investment profile. What follows are four common trading
styles to consider.
Swing trading: This involves holding a trade for a few days or weeks before closing the position.
It is a trading style that is supported by technical and fundamental analysis as traders consider graph
signals as well as supply and demand trends.
Day trading: This CFD trading method is particularly adopted by traders that want to benefit from
intra-day price movements and avoid being exposed to overnight holding fees. Unlike swing trading that
requires traders to be patient before closing a position, day trading is a short-term trading style, but
not as short as scalp trading.
Scalp trading: Typically, when a trader scalps the CFD market, they are opening and closing a
position within minutes, attempting to gain small but consistent earnings, to grow steadily with minimum
risk as possible.
Position trading: Position traders follow one of the basic forms of market analysis through
treds, and unlike a day trader, position traders take a trading position (long or short) for an extended
period of time.
15. Examples of CFD
As mentioned, when buying CFDs, you are not buying or selling the underlying asset. Instead, you are
investing in an agreement with the broker on whether the asset price will go up or down. So, if a trader
believes the asset will go up in value, they buy some units (or go long). And if the trader believes
that the value will go down, they can sell some units (or go short).
The profit or loss in CFD trading depends on the price you enter and exit. The more points the market
moves in your favour, the more profit you make. The difference multiplied by the number of units equals
the number of profits.
However, suppose the market moves in the opposite direction. In that case, the trader will suffer a loss
again calculated by multiplying the difference in movement by the number of units bought. Keep in mind
that in both circumstances, whether the price moves in the trader’s favour or not, they still need to
pay costs associated with making the trade.
16. How to Start
Various platforms are offered in the market by brokerage firms that give access to traders to
participate in the CFD market. By opening an account with FP Markets, you can start trading in CFDs with
an internationally awarded and regulated CFD broker with a deposit as small as 100 AUD or equivalent.
17. Choosing Your
Contract for Differences (CFDs) offers a cost-efficient way to trade on thousands of global financial
instruments, including foreign
exchange, shares, indices, commodities,
bonds and ETFs.
right instrument will greatly depend on one’s knowledge of that instrument. For instance, if you choose
to trade in the foreign exchange market, let’s say particularly in USD/EUR, you should have a good
understanding of the current economic affairs in both countries. Knowing only one side of the coin opens
a trader to unforeseen risks. Keep in mind CFDs are leveraged products that bring amplified returns but
also amplified risk.
18. Deciding on Your
One of the greatest features of CFDs is that it allows traders to take the traditional long position or
the more daring short position. Various factors can influence a trader in choosing which CFD position to
take. The one that must be most avoided is a position based on emotional decision making. Various market
analysis tools are available online with proven back-tested strategies that help remove the emotion for
trading and have proven to help traders gain an edge. Learning to implement technical and fundamental
analysis are also very important skills to understand how to read charts and explore fundamental
economic principles to lead to informed decisions.
19. Looking for the
Best CFD Trading Platform for You
FP Markets offers an evolutionary
fleet of trading platforms that give you access to the global financial
markets at any place and any time. With FP Markets’ Metatrader 4 (MT4) and Metatrader 5 (MT5),
have access to over 10,000 financial instruments and 60+ forex currency pairs along with a personalised
interface, real time volume data and copy trading. Iress Essentials offers an advanced trading toolbox
and an exclusive trading risk manager. Through WebTrader traders can access MT4 and MT5 on their Mac OS
or Windows platform. FP Markets also offers trading on the go facilities via the Mobile
App. They are
designed for high performance and advanced functionality supported by ultra-fast trade execution and the
finest market and analysis tools.
20. Working with a
CFD brokers provide traders with the necessary platforms to open a trading account to buy and sell CFDs.
Some, like FP Markets, also offer a demo account for a trader to practise and familiarise themselves
with CFDs before actively engaging in the market. One of the things to keep in mind is that CFD brokers
earn a fee through the spread. So, the tighter the spread offered the smaller that fee will be. Also,
when working with a CFD broker, traders should make sure that the broker is regulated by a recognised
security commission. This provides traders with the comfort knowing that they can trade through a
platform that is regulated by the highest authority and held to the highest practice standards. Global
recognition is also a good indicator of a broker’s reliability.
21. Risks in CFD
Trading and How to Manage Them
Whenever trading in the financial market, it is crucial for investors to have a risk management process
in place that they strictly follow. This is especially important when trading with leverage, because
although the gains can be magnified, so can the losses which means that it carries a certain level of
risk. To mitigate that risk, it would be advisable to:
Create a trading plan: Limit your investment to what you can afford and clearly outline
goals and expectations.
Avoid over leveraging: Taking on too much leverage can lead to what is called a margin
stop out and could lead to losing the entire investment.
Use a regulated broker: Trading with a regulated broker provides investors with protection
and their deposits are likely to be secured.
Use market trading tools: Markets can change rapidly. By having reliable trading tools,
you can monitor market changes quickly and make informed decisions.
Consider using a guaranteed stop loss: This will automatically close a losing trade once
it reaches a predetermined level.
22. Ready to Trade
Start a demo or
with FP Markets, a globally recognised and award winning regulated broker. A
CFD trading account with FP Markets offers tight spreads as low as 0.0 pips, fast trade executions,
advanced technology with automated traded strategies and over 10,000+ tradeable CFD products ranging
from Forex, Shares, Metals, Indices, Cryptocurrencies, Bonds and Commodities.
Tatiana Freitas, M. D. (2022, January 11). ESMA adopts final product intervention measures on CFDs and
binary options. (2018, June).
Retrieved from European Securities and Markets Authority: