CFD trading allows you to trade derivative products on financial markets such as indices, stocks, Forex and commodities. In practice, you can take a long or short position on the market without ever owning the underlying asset you invest in. In this guide, you will find everything you need to know about trading CFDs, from their key features to how they work.
What Is CFD Trading? – Definition
To begin our analysis, it is useful to understand what a CFD actually is on the stock market. CFDs, or contracts for difference, are financial products that let you bet on the rising or falling price of an underlying asset. These derivatives can track a stock, an index, a commodity, a cryptocurrency and more. In the debate of CFDs vs stocks, ownership is what separates them: with a CFD you never own the underlying asset.
The contract is agreed between a buyer and a seller to exchange the difference between the entry price and the exit price of a position. Closing a CFD order is what determines the profit or the loss.
How CFD Trading Works
CFD trading means buying or selling derivative products based on whether you expect the price of an instrument to rise or fall. When the price moves in the buyer’s favour, the profit equals the number of units selected multiplied by the number of points the price has gained. Conversely, if the price moves in the seller’s favour, the buyer takes a loss.
The best technique is therefore to open a CFD order when you anticipate a rise or a fall in the price of a stock, and to close the position at specific prices set in advance to lock in a given profit or a pre-determined loss. To trade CFDs successfully, the most important thing is to understand how they work and to know the different trading techniques.
The Advantages of CFD Trading
Here are the main advantages of CFD trading:
- Access to a wide range of financial assets: stocks, cryptocurrencies, commodities…
- Powerful leverage
- No restrictions on short selling
- The ability to invest on different financial markets even with a small portfolio
- High liquidity
- Continuous CFD pricing for most instruments
CFD Risks in Stock Market Trading
- Potential losses are larger when trading with CFDs
CFD Leverage Explained
CFD leverage is a kind of loan that allows a trader to invest far more capital than they hold in their CFD account. Leveraged CFD trading therefore makes it possible to trade much larger volumes, both when buying and when selling.
In practice, CFD leverage means opening orders on CFD contracts while using borrowed funds. However, using leverage carries a high risk in the event of losses.
What Are the Costs of Trading CFDs on the Stock Market in France?
CFD trading incurs fees depending on the financial instrument being traded as well as the choice of broker. Here are the costs to take into account:
- The Spread: An essential component of CFD trading, the spread is the difference between the buying price and the selling price of an instrument, and it is considered the compensation of the broker. The tighter the spread, the more you increase your potential gains.
- The Commission: The commission applies only to stock trading. Some brokers do not charge commission fees. If your broker does not bill you any commission, only the spread counts on your CFD transactions.
- Swap Fees: The swap fee is charged when a position is kept open overnight. Generally, it is calculated once a week.
Which CFD Trading Strategies Should You Use?
When trading CFDs on the stock market, several techniques exist depending on your financial goals and the level of risk you have set for yourself. The most popular are scalping and day trading. Here is how these two trading styles compare so you can see which strategy could suit you.
- Scalping: Scalping is a strategy used in CFD trading that involves executing multiple trades over the very short term. This means switching positions within a few seconds or even a few minutes at most. The idea is to buy and sell securities very quickly to take full advantage of the largest price fluctuations.
- Day trading: Day trading is a short-term investment strategy that involves closing all your positions before the markets close. Traders who use this strategy close their position at the end of each day. They make their gains from small price movements. When trading CFDs, they can place several orders on both rising and falling markets.
Our Tips for Successful CFD Trading
- CFDs are best reserved for seasoned investors: educate yourself on how financial markets work and, in particular, on the underlying products of a CFD.
- Ask yourself whether this type of investment will help you achieve your goals, and consider the risks you are prepared to take, knowing that CFDs are short-term speculative products.
- Beware of scams in the CFD market
- Be careful when using leverage to avoid significant losses
- Practise on a demo account offered by your broker to establish your trading strategy properly
CFD Calculation – How to Calculate the Loss or Profit of a CFD Position?
To calculate the profit or loss of a CFD position, you need to take the following elements into account:
- the value of a point or a pip
- the contract’s opening price
- the contract’s closing price
- the position size (number of contracts or lot size)
- leverage
- various trading fees (commission, overnight fees, fees applied when setting up special stop-loss orders)
Calculating losses or profits on CFDs on the stock market follows this formula:
CFD Loss / Profit Calculation = (Position size * Value of a point or a pip) * (closing price – opening price)*
*You will then need to subtract all the various trading fees and taxes to obtain the true profit or loss.
CFD Simulation – Why Use a CFD Demo Account?
It is important to use a stock market CFD simulator to properly learn how CFDs work so that you can establish the best possible trading strategy.
Traders new to CFD trading are always advised to start by using a CFD demo trading account to get familiar with the trading environment of platform comparisons such as MetaTrader 4 (MT4) or MetaTrader5 (MT5).
Indeed, the demo account allows you to set up your CFD trading strategy with virtual money under real market conditions.
CFD Training
More and more courses are available on the internet, so you can choose to learn at your own pace and according to your availability. It is important to train in CFD trading before entering the stock market. Indeed, you can compare all the training offers available.
Many platforms offer their users free training with tutorials to better understand CFDs. All you have to do is follow the right course to improve your knowledge of the markets and create an effective trading strategy.
Before you start trading, make sure you know the basics of trading and the various jargon related to CFDs
Some CFD Jargon to Know
- Margin call: An event that occurs on your trading account when its value falls below your broker’s margin requirement. As a result, you can no longer keep your positions open because you do not have enough funds. You must either add funds or close all your positions to preserve your trading account.
- Ask price: The buying price of an asset.
- Bid price: The selling price of an asset.
- Bull market: A rising market.
- CFD broker : A financial intermediary that allows you to invest in the financial markets through CFDs.
- Hedging: A trading technique aimed at balancing the risks on a trading position by simultaneously opening a long and a short position on the same asset or on highly correlated assets.
- CFD trading robot: A trading tool that allows you to trade the markets in an automated way.
- Spread: The difference between the selling price (bid) and the buying price (ask), which corresponds to the money a broker makes on each trading position you take.
- Stop-loss: A trading order that allows you to control your loss on a position by setting a maximum loss level that will automatically close the position if it reaches that loss level.
- Take-profit: A trading order that allows you to control your gain on a position by setting a maximum profit level that will automatically close the position if it reaches that profit level.
Read also: The Complete Guide to Using MT4 Trading
CFDs: What the Regulator Says
France’s financial regulator (AMF) and the European Securities and Markets Authority strictly regulate the marketing of CFDs to retail investors: leverage caps (30 to 1 at most on major currency pairs, 20 to 1 on major stock indices, 5 to 1 on individual stocks), automatic closure of positions when margin falls to 50% of the required minimum, and negative balance protection. Brokers must also display the percentage of their retail clients who lose money on these products: a figure that is often above half of all accounts. AMF studies on Forex and CFDs showed that nearly nine out of ten retail investors lost money. A CFD is a speculation instrument, not a savings product.
Conclusion: Trading CFDs – Opportunity or Risk?
CFD trading on the stock market offers a great many advantages, especially for a speculative approach to investing. After proper training, understanding how they work is relatively simple.
So, can you make money with CFDs? Yes, but the best approach is to set up money management beforehand to avoid any risk of loss. Indeed, CFD trading is better suited to traders using short-term strategies on highly volatile markets. However, it is strongly recommended to be careful when using leverage, which exposes you to greater risk.
On Which Markets Can You Trade CFDs?
You can trade CFDs on different markets such as the index, stock, cryptocurrency, currency and commodity markets.
Is It Possible to Trade CFDs Without Leverage?
Yes, it is entirely possible to trade CFDs without leverage.
Why Trade an Asset as a CFD?
CFD trading is especially profitable for making money by betting on the rise or fall of an instrument's price. It also allows you to multiply your capital and take advantage of attractive spreads.
What Is the Difference Between CFD Trading and Futures Accounts?
Although these two instruments share similarities, CFD trading and futures accounts differ in terms of the investment horizon. While CFD trading is mainly intended for short-term trading, trading futures accounts allows traders to invest over the medium and long term.
This article has an educational purpose and does not constitute investment advice. Leveraged CFD trading carries a high risk of losing capital; the majority of retail accounts lose money.