When it comes to trading, Contracts for Difference, or CFDs, can be a viable way to get into trading with little collateral and plenty of options. This style of derivative trading requires individuals to partner with a brokerage and use leverage to make the most of the profit potential on offer.
What is CFD trading?
A CFD is a predetermined contract that brokerages offer to traders to speculate on financial market movements in a host of assets and securities (including commodities, stocks, shares and Forex). These contracts pay the difference in an asset’s settlement price between the opening and closing of a trade.
The brokerage will lend the trader money to go alongside the margin amount (the percentage that they ask you to put forward) and this will vary according to the needs of the individual trade, the asset being used, specific trading parameters and potentially your budget - and this is known as leverage.
All CFD trades use leveraging so that more positions can be undertaken by the trader and the potential for multiple, smaller trades can be added together for a worthwhile profit. While all types of trading will have risks, CFDs have additional pitfalls due to leveraging that need to be understood before putting your finances on the line. The biggest risk is that losses are taken across the whole spread, so they are likely to be larger than you’d expect and can add up quickly.
Benefits of CFD trading:
There are a host of benefits when trading CFDs including increased earning potential (as mentioned above), there is the ability to trade on both increases and decreases in market sentiment, otherwise known as bear and bull markets, flexible lot sizes and an array of hedging options. You can also expect:
- No expiration dates
- Lower trading costs
- UK taxation perks
- Low entry point for traders with little collateral
- The potential to earn more from trades as your experience and confidence grows
Finding the right trading platforms:
Before we dive into what CFDs are, let’s learn a little bit about trading platforms. Modern brokerages like CMC markets will offer their very own platforms and software to provide a host of tools and trading insights to traders of all calibers. Some will be designed with beginner traders in mind, while others will priorities functions for more skilled individuals to make use of - and all will offer leverage (more on this later).
Trading CFDs will only be possible with the support of a broker, so make sure the platform you choose is reputable and has the necessary security and authority backing. This may still leave you with a host of options, so be sure to look out for the features that align with your trading needs (such as budget or chosen strategy). Try to select a brokerage that offers a demo trading account, as it can be worthwhile to practice before risking your finances.
A word about leveraging
It’s important to know that while profit potential will be increased, so too will losses. No trader has a 100%-win rate, no matter their tools or experience, so it’s always a good idea to practice risk management. Losses won’t only be taken on your percentage of the trade - they will be calculated across the entire position, so be sure to work out exactly how much you stand to lose if things don’t go your way.
While you may be tempted to take up as many positions as possible, or ones of a higher value, starting off small and then reinvesting your wins into fresh trades to build collateral can help you to minimise the chances of trading emotionally and potentially losing more than you can afford.
Are trading strategies necessary?
Making a plan to define how and why you want to trade will help to set you up for success. Be sure to think about the money you have to trade with and how much you can stand to lose, how much you aim to make (will your profits add to your current earnings, or do you want to make trading your main source of income?), as well as your preferred markets and any potential strategies. Trading strategies can be a worthwhile implementation to maximise your trading potential, so here are the top 3 types for CFDs:
This strategy involves traders placing two trades on the same asset type, with the aim of profiting from the size of the movement between the two. Traders will go long on the weaker asset and short on the stronger one - and the greater the disparity, the greater the profit.
When traders have the right time and commitment, scalping is the ideal strategy. It requires traders to take small positions in bulk throughout one trading session, spreading and minimising the usual risks. The small wins should add up, but only with significant commitment.
Long term trading
One of the top benefits of CFD trading is that these contracts don’t have an expiration date, so you won’t be limited in the positions you take on. Long-term trading will be subject to fees, so be sure to budget properly and be aware of all the outgoings to ensure that profits outweigh the losses as often as possible.
Can anyone trade CFDs?
With a decent budget and the right time and effort, anyone has the potential to trade CFDs. As this trading method is supported by brokerages and a host of tools and software that can give deep insights and automate trades, beginners will have worthwhile assistance and those with experience will have the ability to tailor their trading experience to suit their needs.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Marketing for CFDs and spread betting is not intended for US citizens as prohibited under US regulation.