If you’re an experienced trader or just curious about trading, chances are you know of contracts for difference (CFD) trading. CFDs are derivative investment products where a trader can speculate on the price movements of an underlying asset.
Because you’re trading a contract, rather than owning the underlying asset, CFD traders can profit regardless of whether prices are going up or down. For that reason, CFD trading often becomes more popular during times of market volatility. In tough economic times, traders seek to profit by ‘shorting’ the market.
While CFDs can be profitable, they’re also high risk and complex products they are suited for experienced traders. This guide offers a complete overview of CFDs, including how they’re traded, some trading strategies and what risks are involved.
CFD trading explained
A contract for difference (CFD) is an agreement based on a financial instrument or market, such as a share, index, commodity or currency pair. CFD trading is a popular type of derivative trading. In the contract, you can decide if you believe the underlying asset will increase or decrease in value between the time the contract was initially opened and when it is closed.
Keep in mind that the trader does not actually buy or sell the asset in question. Rather, the trader is entering an agreement to exchange the cash difference between the initial and closing price of a position.
Why trade CFDs?
CFDs allow you to speculate on thousands of financial products and global markets which you may otherwise be inaccessible.
You can profit in both rising and falling markets.
You can usually access free demo accounts, plus charts and trading tools through your broker.
Unlike other types of derivatives, CFD contracts don’t have a fixed expiry date, meaning you can close out your position (in other words, end the contract to realise a profit or loss), when you decide.
Is CFD trading in Canada legal?
CFD trading is legal in Canada, but it is a heavily regulated market. Any broker operating in Canada, or opening accounts on behalf of Canadians, must comply with the regulations. The standards are set by the Investment Industry Regulatory Organization of Canada (IIROC). On their website, you can access the “Dealers we regulate” page which lists all regulated brokers. Generally speaking, these are the best CFD broker resources to use. You can consider other providers, but they may not be the best CFD provider if they’re not regulated. The IIROC is overseen by The Financial Institutions Supervisory Committee (FISC). In the event that a brokerage fails, regulated CFD brokers receive cash protection up to $1 million CAD.
Unfortunately, the regulations don’t stop there. At the local level, The Ontario Securities Commission, The Autorité des Marchés Financiers and The British Columbia Securities Commission also set regulations for CFD trading in Canada.
If you choose to participate in CFD trading, it is your responsibility to ensure compliance with the regulations in Canada.
What are the risks of CFD trading in Canada?
CFDs are extremely risky, complex products and are ideally suited to experienced traders. Here are some of the potential risks that you should know about before deciding if CFD trading is right for you.
CFDs are complex. CFDs are very intricate and confusing products. Even if you have a general understanding of what a CFD is, this doesn’t mean you’re ready to start trading CFDs or will turn a profit.
You can lose more than your initial capital. If you gamble on a poker machine, the most money you can lose is the amount you put into the poker machine. This is not the case with CFDs. If you lose a CFD trade you can lose much more money than you started with. This means you actually owe the CFD provider money, sometimes hundreds of thousands of dollars.
You don’t own the underlying asset. When trading CFDs all you own is the contract between you and the CFD provider. Therefore you can’t benefit from the capital growth of the underlying asset over the long term.
CFDs depend on how the market performs. Even though you don’t own the underlying asset, CFDs are still affected by market conditions. This can increase risks even more in a volatile market.
High leverage. Traders are only required to pay a small amount of the money invested into each trade. The remainder can be borrowed from the trading platform – sometimes as much as 30 times the invested amount. Borrowing high amounts to invest is always risky.
Extreme volatility. CFD trading frequently occurs during market volatility. The value can swing back and forth in extremes without notice. Even in non-volatile markets, this can be true.
Low liquidity. Because CFDs are so complex, there aren’t as many buyers available compared to other assets like houses or stocks. This means you may struggle to find a buyer when you want to close out your position. The opposite is true too. If you want to buy a CFD, you may struggle to find a seller.
What can you trade with CFDs?
Some of the most common markets you can access with CFDs are shares, indices, commodities like oil or gold, metals like copper and forex in the form of currency pairs.
However, you’re not limited to these. CFDs allow you to speculate on many more markets like bitcoin and other cryptocurrencies, government bonds and even big events such as national elections. If you want to trade CFDs, you need to fully understand how the CFD itself works as well as the underlying asset. For example, if you have no experience trading shares, it may not be a good idea to buy a shares based CFD.
How to decide if CFDs are right for you
Due to the complexity and high level of risk involved, CFDs will not be suitable for the vast majority of traders. CFDs could be right for you if you:
Are an experienced trader
Have a strong understanding of not only CFDs but many financial products and markets
Possess a high tolerance to risk, and are not at all risk-averse
Can afford to lose quite a bit of money (it’s not guaranteed that you will, but you need to be comfortable with potencial loss)
Have some level of legal expertise to understand the complexity of CFDs
Are not interested in owning the underlying assets
Understand the measures available to minimize your risk and are experienced using these tools, for example stop-loss orders
Have conducted plenty of research – trading CFDs is not a decision that should be taken lightly
How to choose the best CFD trading platform
Choosing the best CFD broker can take time. The best CFD provider available will depend on your trading style and what instruments or assets you prefer to use. If you’re looking for the best online platform or app for you, consider the following:
Available markets. Does the broker offer forex (foreign exchange market), gold, silver, cryptocurrency, stock market indices, global stock CFDs, TSX CFDs
Direct share CFDs. Not all brokers offer CFD trading on shares, and some that do charge an additional subscription fee to access them
Currencies. If you’re looking to trade forex, check whether your preferred pairings are being offered
Commission fees. There’s often a brokerage fee charged when trading stock and stock index CFDs, check it’s not too high
TSX live data. Does it charge a fee to access live stock market data from the TSX and other stock market indices?
Minimum opening balance. Some brokers require a high minimum opening balance before you start trading – consider trialing the demo version first if it has one
Platforms and software. Which trading platforms do they offer and can you add-on software or analytics tools?
Other types of trading. Do you also want to invest directly in shares, ETFs, forex or managed funds?
CFD trading is quite advanced. If you don’t think you’re ready, you can always work with other kinds of trading. Below are some alternatives to consider:
Leveraged ETFs. A leveraged ETF is a security that uses leverage (i.e. borrowed funds) to enhance the returns of an underlying index. Traditional ETFs usually track securities in its underlying index on a 1:1 basis. Leveraged ETFs aim for a 2:1 or 3:1 ratio.
Options. An option is a contract between a buyer and a seller that offers the buyer the right to buy shares of a particular stock, bond, commodity or other asset at a later date. Options are traded in contracts that define the “strike price” and other conditions. They are popular among experienced traders because compared to stock trading, they generally require less money up front with the potential to earn more.
Futures. A future contract is an agreement between a seller and a buyer that a specific asset will be bought or sold at a specific price at a specific day in the future, better known as the expiration date. The asset is usually a commodity, currency or stock.
Foreign exchange market (forex). The foreign exchange market involves trading of foreign currencies. There isn’t a specific marketplace for forex trading – it’s an over-the-counter transaction.
Bottom Line
CFD trading is complex and high risk. For this reason, beginner traders should gather more experience before participating in CFD trading. If you’re an experienced trader, finding a CFD trading platform and starting to trade may be a great choice for higher returns.
Frequently asked questions
When you trade CFDs, you never own the actual underlying asset; instead, you bet on its price movements. In short, what you actually purchase is a contract. When you invest in shares, however, you buy and sell the shares themselves.
Some of the underlying assets that you can trade CFDs on include Canadian and international shares, indices, commodities, foreign exchange and treasuries.
Trading CFDs is not recommended for casual investors. Because of the specialized knowledge required and high level of risk involved, this type of trading is best left to expert investors.
Wrong. Because you are trading with leverage, it’s possible to end up losing significantly more than your initial investment amount.
The best way to find a good trading platform is to do plenty of research. As well as right here at finder.com/ca, you can find plenty of useful information on blogs, forums and the websites of individual providers. Examine the features and benefits each trading platform offers and open a demo account if possible to try before you buy.
While you can certainly learn useful information at a training seminar run by a reputable financial or training organisation, attending a course is by no means all you need to fully prepare you to trade CFDs.
No, CFD trading is risky and far from a steady investment option. If you’re looking for safe and secure returns on your money, consider other investment opportunities.
TSX exchange-traded CFDs are CFDs that are listed on the Toronto Stock Exchange (TSX). With terms and conditions set by the TSX, these are slightly less risky to trade than other CFDs and can be traded through brokers that have been authorized by the TSX.
When you buy shares in a company you are usually entitled to dividends, and although trading CFDs means you never actually purchase shares, you can still take advantage of some of the benefits of ownership. When you buy a CFD, your trading account will be credited with a certain amount of money that reflects the dividend amount an ordinary shareholder would receive. When you sell a CFD, your account will be debited a similar amount which will be paid to the counterparty.
No, there is no real minimum limit when you trade CFDs.
The exact process for buying and selling CFDs will vary depending on the trading platform you choose. Contact your trading platform operator for detailed information and instructions.
Yes there is, but this differs between trading platforms. A commonly quoted minimum limit is $5,000.
No. Wealthsimple CFD trading doesn't exist. Wealthsimple does not support CFD trading in Canada
CFD and share trading glossary
Ask or Ask price. This is the price at which you can buy CFDs
Bid or bid price. This is the price at which you can sell CFDs
CFD (Contract for difference). This is a contract entered into by two parties who agree to exchange money according to the change in value of an underlying asset.
Contract currency. This is the currency in which a particular asset is traded.
Dealing. Dealing is when you open or close a CFD position.
Derivative. A financial instrument whose price is derived from an underlying asset.
Going long. When you open a buy position.
Going short. When you open a sell position.
Hedging. Taking an opposite position to reduce the risk associated with an initial position.
Initial margin. This is the minimum deposit required when you wish to open a CFD position.
Leverage. Leverage allows you to trade a larger value asset than the worth of your initial investment. This is sometimes also referred to as gearing.
Open interest. This is the interest rate that applies to all CFD positions that are held open overnight.
Stop-loss. A stop-loss order can be placed when a CFD position is opened and is triggered when the price reaches a specified level. These orders are used to close out positions that have resulted in a loss and aim to prevent further loss.
Important information: Powered by Finder.com. This information is general in nature and is no substitute for professional advice. It does not take into account your personal situation. This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for most investors. You do not own or have any interest in the underlying asset. Capital is at risk, including the risk of losing more than the amount originally put in, market volatility and liquidity risks. Past performance is no guarantee of future results. Tax on profits may apply. Consider the Product Disclosure Statement and Target Market Determination for the product on the provider's website. Consider your own circumstances, including whether you can afford to take the high risk of losing your money and possess the relevant experience and knowledge. We recommend that you obtain independent advice from a suitably licensed financial advisor before making any trades.
Veronica Ott was a writer at Finder. She's written for numerous finance and business websites including Loans Canada, Borrowell and Fresh Start Finance. She previously worked as a professional chartered accountant in the private equity and advertising industries. See full bio
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