Before you can learn to trade CFDs, it’s important to understand what they are and what they are not. CFDs, have been around since the early 90’s and were primarily used by hedge funds and institutions to trade stocks and shares on margin. However, over recent years, with the rise of online trading platforms, retail investors have been able to trade forex, indices and commodities (as well as shares) via contracts for difference.
What is CFD trading?
A contract for difference (CFD) is a leveraged financial product that allows traders to speculate on an asset class without actually owning the underlying asset.
It is very important to highlight that CFD trading is not investing. It is very high-risk speculation, and as CFDs utilise leverage it is possible to lose all your money quickly if you call the market wrong.
- Related guide: 50 rules for successful trading
However, if you call the market correctly, you can make a greater return on your money than by investing in fully paid-up physical stock as you are trading on margin.
CFD trading also has the advantage of not being liable for stamp duty which is currently at 0.5% of the value of a trade. This makes CFDs a more efficient way of trading stocks and shares in the short-term.
The key points to remember are that CFDs are a good tool for short-term speculators compared to physical stock buying as the costs are lower, but as CFD trading is leveraged, then the risks are higher.
- A complex financial derivatives product
- A tool to go long and short the market, or hedge an existing portfolio
- A form of leverage trading that can increase your exposure to the market
CFDs are not:
- A low-risk way to invest
- Suitable for traders with no experience
- A get-rich-quick scheme
Industry experts told us"CFDs, provide one of the most versatile ways to take a position on financial markets going up or down. They are an essential product for any trader who is either hedging a long-term portfolio or for short-term higher-risk speculation."
How do you trade CFDs?
When you trade CFDs you do it in much the same way as trading shares. In that if you want buy 10,000 shares in a company you would instead go long 10,000 CFD.
It is essentially the same as buying 10,000 shares, but when you trade a CFD you speculate on the rise or fall of the price of the underlying instrument that the contract is over, without ever owning it, meaning that your interest in that instrument is purely economic.
CFDs or Contracts for Differences are cash-settled, and there is no delivery of shares or commodities, or whatever else the CFD is over.
Unlike futures contracts CFDs have no fixed expiry dates and in theory, a CFD can run on forever.
Though daily financing charges are applied on CFD trades that are held open beyond a business day, and they may make very long term CFD positions uneconomic.
An example of CFD trading explained
Let’s imagine we want to take a long (buy) position in Vodafone shares, but rather than buying the stock we choose to buy a CFD over them, and we have £5000.00 available to us for the trade.
Assuming that Vodafone shares are trading at 100p we could have invested £5000.00 into the stock to buy 5000 shares.
But using as CFD, which on leading equities typically offer leverage at a ratio of 5:1 we only need to commit £1000.00 to the trade to control a CFD over 5,000 Vodafone shares.
On that basis then might choose to take on a larger position, by using a deposit of £2000.00 to create a CFD over 10,000 Vodafone shares.
So, imagine that we have placed the CFD trade in the morning and that just before Wall Street opens Vodafone’s share price has risen to 110p per share – compared to our 100p entry price.
We now have running profit on our position of +10p per share – true for both the physical stock and the CFD trade.
However, because we have taken a larger position in Vodafone, using a CFD we have a larger running profit.
How to calculate running profit on CFD trades
In this case, that’s calculated as follows:
10,000 (the number of shares in our CFD) * 10p the running profit per share) = £1000.00.
Let’s imagine that the price of Vodafone continues to appreciate throughout the afternoon and that by 4.15 pm the stock is trading at 115p per share.
The running profit on the CFD position has now reached 15p per share and we cash in by selling our CFD position to close realising a gross profit of £1500.00
10,000 *15p = £1500.00
Our outlay on the CFD trade was £2000.00 initial deposit plus a commission or trading charge, and we have made a £1500.00 gross profit.
A figure that represents 75% of our initial deposit on the trade.
When we compare that to the profit we could have made investing £5000.00 into Vodafone shares, which is £750.00 or 15% of the initial outlay of £5000.00. We can immediately see how the gearing or leverage within a CFD can work in our favour.
What are the advantages of CFD trading over other forms of trading?
CFDs are among the most flexible of financial trading products and they can be tailored to fit all shapes and sizes of trades.
|Feature||CFDs||Physical Investing||Exchange Traded Futures||Spread Bets|
|Flexible Trade Sizes||Yes||Yes||No||Yes|
|Fixed Expiry Dates||No||No||Yes||Varies|
|Trade Long or Short||Yes||No||Yes||Yes|
|Good for Short Term Trading||Yes||Varies||Yes||Yes|
|Good for Long Term Trading||No||Yes||Yes||No|
|Confers Ownership of the Underlying||No||Yes||Yes||No|
One of the best things about CFDs is that they are not deliverable and instead are settled for cash. That means that traders can go long or short using CFDs with equal ease, as they never have to take or make delivery of the instruments that the contract is over. As such CFDs can be used to profit in markets that are falling or to hedge physical positions against a downturn in the markets.
There are no absolute minimums in terms of cash required to open a CFD account but realistically you will probably need to have an initial deposit of at least £2000.00 for it to make economic sense. And ideally a figure closer to £5000.00 is preferable. Smaller sums limit the scale and number of positions you can take and CFD traders with small deposits can face higher marginal costs in terms of minimum ticket charges etc.
Short-term trading tends to be driven by sentiment which these days is often categorised as being either risk on or risk off. So it’s important for traders to be able to identify times when the market and fellow traders are feeling fearful and other times when they are feeling greedy.
Many CFD traders play the swings in market sentiment by jumping on to the trends they create, where weight of money and influence push the market in one particular direction.
More experienced traders will sometimes take a contra position for example getting long risk assets such as equities, when the market is in a risk off mood. This is often referred to as buying the dip. However deep pockets and good timing are essential for that strategy to work well.
One way for CFD traders to identify trends and trend changes in the market and the instruments they trade, is through the use of Technical Analysis which is the study of price action and volume.
The study of price action can reveal a great deal about market and trader sentiment and the price points at which bullish or bearish sentiment is triggered or fades away. That in turn can provide a framework around which traders can build their CFD trading strategy.
To learn more about technical analysis see our dedicated TA section.
What are the disadvantages of CFD trading
The main disadvantage of CFD trading is leveraged losses on CFD trades. That leverage can work against us just as easily and had Vodafone shares fallen by -15p across the trading day, then that CFD position would have created a running loss of -£1500.00.
We would either have had to close the position and realise the loss, or place further variation margin, equivalent to the running loss, on our account, in this case, £1500.00 in order to keep the position open if we wished to hang on to trade.
You also do not own the underlying asset, so unless our broker allows it you will not be able to vote on corporate actions or attend AGMs. This also means that there is added risk of default. When you own physical shares you are the ultimate owner so if you broker goes bust you still own the shares. However, with CFDs, the counterparty is the broker, so if they go bust you may lose the position.
What are the major costs involved when trading CFDs?
CFD trading platforms make money in two principal ways firstly if they act as agents they earn a commission on each trade their clients make and an income from the overnight funding charges they levey.
However they may also act as principal in which case they make prices to their clients and capture the spread between those prices, they oppose their clients trading taking an equal and opposite position. Under this model the firm will profit if the client loses and lose will if the clients profit.
In an age of computerised trading firms often operate a hybrid model under which certain trades and clients receive an agency execution service, whilst others are “B”- booked i.e. the firm takes on the clients trade on its B or principal book. Those B book positions may be hedged from time to time based on internal market exposure rules.
Note though that in CFD trading whether your trade execution is under agency or B-book arrangement your trade counterparty is always your CFD trading platform or provider.
If you are trading CFDs or spread betting on stocks here are six hidden costs and dangers that you probably haven’t though about.
Trading OTC or “over the counter” products such as CFDs & spread betting will always be dangerous and especially risky if you are dealing on margin, where you can lose more than your initial deposit.
You should be aware of that fact as pretty much every financial promotion, website, account form and contract note will have a risk warning on it somewhere.
Although according to the FCA’s insight website we may all be suffering risk warning fatigue.
So, other than making or losing huge sums (relative to your initial margin) what other dangers lurk in the shark “invested” waters of ultra high-risk CFD trading?
Here’s a list of things to watch out for when trading CFDs.
CFD trading commission or spread widening
There are generally two types of execution charges for trading CFDs. Either commission with clean prices, or no commission with a widened spread.
If you get charged commission it means you buy or sell at the actual bid/offer or inside if you are using a DMA (Direct Market Access) broker.
If you are being charged a spread then you won’t get charged a commission, but you will be buying or selling at a price slightly wider than the bid/offer. So for example, if a stock is trading 101/102 your price maybe 100.9/102.1.
The spread is usually widened inline with what the commission would be. In this case 10 basis points or 0.1%You will agree to a commission rate when you open an account phrased either as “basis points” or as a percentage.
If you are spread betting you may find a broker who can offer you DMA on some smaller stocks by getting them to work an offer in the underlying market. But generally, you will be charged a widened spread.
If you are charged 0.1% commission that’s £100 on a £100,000 trade or 10 basis points. They are the same, just different terminology.
Normally, most brokers are quite clear about this, but it is worth checking you are not being charged double. If you have a high commission and don’t get market prices, it may be time to change your broker.
For larger traders paying commission and trading, DMA means you can trade inside the best bid/offer. The ability to get within the spread can often compensation for paying commission on wider prices.
CFD interest on overnight positions.
Just like when you borrow money from the bank, when you are trading a CFD you are borrowing to do so, and there is an interest rate attached.
A long time ago, when I opened my first CFD account I vividly remember the salesman saying, “well you get charged around 2.5% over/under base, but you shouldn’t really factor that into your trading”.
Hmmm, not LIBOR base, the firm’s base, which depending on the currency can currently be above 3%.
So that’s 3%+2.5% or 5.5% on your positions size (depending on the first it will either be the initial position size of the daily, you need to check).
So if you buy £100k of stock and hold it for a year that’s £5,500 in interest charges.
As with everything else in trading these rates are negotiable if your account is large enough.
FX currency deficits on CFD trading P&L
Most CFD trading platforms will have your account in one currency and do automatic currency conversions into that currency when you have a different currency P&L.
But your broker may have a treasury cost to running a book in multiple currencies and will charge accordingly.
So, if you put £100k on your account and trade GBP stocks, but then buy $100k of US stock on 10% margin. You have a GBP but no USD. So you are essentially running a USD overdraft to fund the USD position. You may not have a margin call, because your GBP nets off the USD.
But as your broker has bought the USD stock to write a CFD around, they have still had to lodge USD with the exchange for the purchase, and will, therefore, pass the costs of this on to you.
Some institutional or professional brokers are reluctant to do automatic FX conversions for clients trading in different currencies, as some like the currency exposure.
Plus a currency can move 10%, so your broker would be susceptible to client complaints if the 10% move was in their favour.
If you are trading on markets around the world, make sure that you regularly check your currency exposure and instigate conversions where necessary.
What are the best CFD trading strategies?
CFD trading platforms offer the facility for you to trade the financial markets, but only you can implement a winning strategy to make money trading.
If you are looking for a CFD trading strategy, these three golden rules are a good place to start.
1) Run your wins, cut your losses
This requires discipline and one of the main reasons that people lose money trading is because they are too eager to lock in a profit. trading CFDs is a numbers game and the best hedge fund managers in the world only get it right about half the time. That means that half of the trades they execute a loss. The market is based on trend and reversion so technical analysis plays a high part in short and long-term CFD trading. If you call a trend-right you are going to make money if you leave the trade open, if it a loser cut it straight away. You can do this by using a stop loss or a trailing stop loss.
2) Don’t overtrade
If you only have £10,000 to play with you definitely don’t want to put all that into one trade. Sure if it’s a winner great but if it’s a slow mover or a loss then you are stuck and won’t be able to enter into any new positions when potentially profitable opportunities come up. Plus, if there is a shock short-term overall market then you’ll get a margin call and be forced to close your positions because you can’t cover the variation margin. Being forced to close a position is one of the worst things that can happen to your trading strategy.
3) Diversify your positions
One of the great things that CFD brokers provide the facility for is making money when the market goes down. This means that you can have a wide range of positions but actually remain fairly market neutral. For example, if you are short some individual stocks because you think they are badly managed then you are exposed to an upwards move in the markets. So you can hedge using a CFD position in the underlying index to protect against this. You could also have some long positions in similar sector stocks as some protection.
The key thing to remember is that profitable CFD traders don’t open massive single positions and hope for the best.
If you want CFD trading tips, most financial media produce daily buy and sell recommendations which are often a good source of stimulus.
One thing to remember though is that stock tips in the papers are usually based on fundamental analysis with a longer-term view as opposed to CFD trading which usually employs market timing and technical analysis as this is more relevant for short-term price moves in liquid stocks.
Here are our top providers for CFD trading ideas and tips
- An FCA-regulated CFD trading platform – most CFD brokers can provide analysis and trading signals. City Index for example has an excellent trading signal section called SMART Signals.
- Investors Intelligence – since 1942 they have provided daily long/short trading ideas and model portfolios
- Stockopedia – set up screens and get trading ideas from fund manager strategies
- Trading Central – trading signals based on technical analysis
- Autochartist– trading signals based on technical analysis
- Stockomendation – aggregates stock recommendations
- FuturesTechs – subscription service for professional and semi-professional traders
- Good Money Guide – our daily updated trading signals feed displays potential buy and sell targets for UK stocks
These services act independently from CFD trading platforms and are in some cases regulated by the FCA .They often highlight trading signals and CFD trading buy and sell signals, but it is up to the trader to decide if they are any good and worth of a trade.
You can also get a form of CFD trading tips from the social trading brokers, where you can follow traders and copy their trades. But, picking a trader to follow is just as hard as picking a winning stock. If you look at the people that make money on social trading platforms a lot of them mirror the portfolios of top global growth funds or have just had a bit of luck.
Where to trade CFDs?
Most established CFD trading platforms have one or more of these services integrated into their CFD trading platform or provide it through a subsidised or separate subscription if asked. If you are looking for a CFD broker you can view our CFD account comparison tables, read our guide on how to compare CFD trading platforms or find out what to avoid when choosing a CFD platform.
How to trade CFDs FAQ:
CFD trading means contracts for difference. Instead of buying physical shares, you are entering into a contract based on the difference in price between when a position is opened and when it is closed.
A CFD trading account is provided by a CFD broker so clients can trade the financial markets via CFDs as opposed to buying or selling physical shares.
No, US residents cannot trade CFDs. However, non-US residents can trade US shares and markets with a CFD broker that is regulated by the UK FCA.
Leverage enables CFD traders to get more exposure to the financial markets by putting down a small deposit for a larger position. Typical leverage ranges from 5x to 20x the amount of capital you deposit on your CFD trading account.
CFDs are available on most markets with the leading brokers offering thousands of different instruments to their customers. These can include large, midcap and small cap equities, ETFs and bespoke baskets that track sectors or themes. Equity indices, commodities such as oil , gold, copper, coffee and cocoa etc, as well as bonds and interest rates. It’s also possible to trade cfds on options on many of these markets as well.
Stock indices are the most popular markets with indices such as the Dax 30, the FTSE 100 and the Nasdaq 100 being particularly actively traded, As much as 60% of the revenues of leading CFD and margin trading providers are derived from index trading.
MT4 is one of the world’s most popular FX trading platforms and you can trade a limited number of CFDs through the platform. Typically these are leading equity indices, a selection of commodities and large cap US equities, though the exact composition of the offering will vary by broker.
The introduction of CFDs on ETFs has opened a whole range of new trading possibilities for clients, through instant asset allocation; there are thousands of ETFs which track almost every asset class and trading strategy. So for example if we want to be long US high yield bonds, short Japanese smaller companies, and long solar power we can place that trade using CFDs.
An asset class is simply a group of financial instruments which share common characteristics; the major asset classes are equities, bonds, interest rates and credit, commodities, FX and alternatives. Each of these headline asset classes contains a series of subsets for example mid cap equities, soft commodities, government bonds, investment grade credit and FX crosses.
And in several cases we can group the asset class components by their traits, and return profiles. Which are known as factors, which include classifications such as value, growth momentum, quality etc.
Having that level of granularity means that CFD traders can quickly create trades that only a few years ago were limited to large hedge funds and investment banks.
To place a CFD trade, follow these steps:
- Compare CFD trading platforms to see which one is right for you
- Open an account with a CFD broker by confirming that you understand the risks involved
- Deposit funds into your account
- Search for a market to trade
- Buy CFDs is you want to go long or sell CFDs if you want to go short
No, CFDs are a highly leveraged derivatives product, and the majority of retail investors lose money. The leverage or gearing used in CFDs can create substantial P&L swings. The more gearing employed then the bigger those P&L swings can be.
CFD traders need to manage their risk as it’s possible to lose more than your initial investment if the position goes against you. On a long position, your maximum possible loss is the notional value of the contract – in our Vodafone example above, that would be £10,000.
However, if you have a short CFD position, an open-ended or infinite loss is theoretically possible, as there is no upper limit to how high the price of a financial instrument can rise.
To make money trading CFDs you need to spot the emergence of trends in price action or identify new information and news flows and anticipate the price moves that this will create. CFDs are popular with intraday swing traders who are often very active, particularly in CFD contracts over the world’s major equity indices.
CFD traders will also need to factor in their trading costs which include commissions and daily financing charges, but they must also remember that unlike spread betting, profits made in CFD trading attract UK capital gains tax, under current legislation.
CFD accounts are usually opened via an online application form, though some brokers which offer a wider range of services may take you through the application over the phone.
Typically you will need to prove your identity and address, and demonstrate a source of funds. You will also need to show that you have a good understanding of the risks involved in trading geared instruments; this is usually done by taking and passing a short quiz on the subject.
If the broker can verify your identity and address electronically you may not need to submit documents, but if for some reason they cannot do so then you may be asked to submit copies of your passport or driver’s license and recent utility bills.
Once your account is approved then you will need to make a deposit to fund the account. Payment methods can vary from broker to broker but most will accept debit or credit cards, bank transfers and in some cases transfers from electronic wallets such as paypal, neteller or skrill.
To place a trade you will need to have downloaded, installed and logged into your trading platform. Once your account is funded your deposit should be visible on the platform and then you’re ready to go.
You will need to choose a market to trade in and once that’s done you can create an order by opening a trade ticket, choosing the direction of your trade (buy or sell) your trade size and the order type you wish to place. For example if you want an instant execution you will place a market order. However if you want to execute at a particular price level you can use a stop or limit order to do so.
Certain trading platforms also allow you to nominate take profit and stop loss levels at the outset of a trade and with others you can add these details post execution.
This varies depending on broker, but when a share is suspended and you have a CFD position, most likely the risk department will raise the initial margin to 100% (or 99.99%) until the stock comes back.
The issue here is that you will have to fully capitalise the consideration, but you will still have a CFD position, so will be charged over/under CFD interest on something that is fully paid up.
Also, as a result your account may go overdrawn where you will probably be charged deficit interest.
This can be as high as 15%. So bear in mind that your running costs are now 15% plus 5.5% or 20.5% if your long/short rates are as above.
So this is one to avoid, or at least try and get confirmation from your broker prior to entering a trade that you can swap it into an equity position or they will waive the charges if a CFD position share is suspended.
You’ll be less likely to encounter this sort of problem if you stick to the large-cap stocks in the FTSE 350. But, if you are dealing with a decent broker, you should be able to talk to them and negotiate reduce rates under special circumstances.
Yes. Normal practice is to pay 90% as they are taxed at source if you are long, but charge 100% if you are short.
However, as CFDs are OTC you are not the beneficial owner of the shares, your broker is (if they hedged the trade) so are not obliged to pay you the entitled dividend (usually on the ex-div date).
Check your broker’s dividend rates, most are pretty good as it is just a cash adjustment and becoming a popular way to enter positions.
Risk departments have the right and the responsibility to change initial margin rates when stocks become less liquid or more volatile. Or when currencies may become susceptible to massive price moves because of political events.
Yes. This is for the broker’s protection as well as the client’s to ensure that everyone can meet end-of-day commitments.
Be prepared that if you are trading in volatile or illiquid stocks that your margin rate can be increased with no or very little notice.
So ensure you are not fully invested and have capital for extra initial and variation margin.
There are two types of CFD trading tips.
- Tips on what to buy and sell,
- Tips on how to improve your trading.
We’ve covered strategies to improve your CFD trading which covers the basics, but if you are looking for CFD trading ideas on what to buy and sell here is what to look out for and what to avoid.
But first, a quick note on risk: If you don’t know what CFD trading is or what CFD trading means you probably shouldn’t be doing it. Are advisory CFD services any good? In a nutshell, no. The FCA has all but put a complete stop to high-pressure sales tactics used by rogue advisory CFD brokers to fleece their clients.
The days of getting pitched stocks by an ex-Carphone Warehouse salesman are over. They moved to binary options, but have now moved offshore to flog crypto trading scams.
However, what this has meant is that the traditional and reputable CFD trading platforms are no longer allowed to give advice or even implied advice on what to buy or sell when CFD trading to retail or private clients.
If you’re a private client all you’ll get from brokers is some fairly bland market commentary or some non-commital technical analysis.
CFD trading platforms are allowed to advise professional or institutional clients and give them CFD tips, but it’s unlikely that any properly regulated CFD stockbroker in the UK can give tips to correctly classified private traders.
So, if an advisory CFD broker is pushing trading ideas, make sure you double-check who you are dealing with. As they shouldn’t really be doing it.
Trading educational courses for tips and CFD trading ideas avoid like the plague quite frankly.
There are some good trader educational programs out there but the majority of forex or CFD educators are just trying to flog you a premium lifestyle at a premium price or refer you to an offshore broker where they will share in the profits made from you losing your money.