CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.Between 61%-75% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
If you’re a beginner investor, contracts for difference (CFDs) aren’t a good place to start as they’re risky and complicated. If you’re a more experienced investor, here’s where you can find out more about CFDs and compare platforms that sell them.
What is CFD trading?
CFD stands for “contracts for difference”. CFDs let you trade on the price movements of shares, indices, commodities and currencies. While traditional investing involves aiming to make a profit through dividend payments or the rise in value of shares you own, CFDs involve betting on which way the price of a particular asset will move. CFDs are classed as “derivative” financial products, this means that their price is derived from the underlying price of a particular asset. Unlike options and futures contracts, CFDs do not have an expiry date.
When you trade CFDs you don’t own the underlying asset, like you do with stocks and shares. Instead, you borrow money to bet on the short-term rise or fall of a financial instrument such as shares in a company. If your prediction is right, you can make a profit; if your prediction is wrong, you can suffer a loss.
CFDs are becoming an increasingly popular trading option for investors in the UK and around the world. This is largely because they offer the potential to enjoy substantial gains with a smaller amount of starting capital, because you can borrow money (leverage and margin). This rise in popularity is reflected by the increasing number of online brokers making it possible for investors to trade CFDs from the comfort of their own home.
However, CFD trading comes with substantial risks attached. With leverage (borrowing), you can end up losing significantly more money than you initially invested. The appeal is that leverage allows you to potenitally amplify profit but it can also lead to a magnification of losses. With this in mind, it’s important that you know what you’re doing and that you have an in-depth understanding of the risks involved before you start trading CFDs.
How can you trade CFDs?
There are loads of technical terms when it comes to trading CFDs and it’s more complex than just buying shares as a long-term buy and hold investor. Here are some of the ways that CFDs are traded:
Buy in a rising market
If you expect the asset to increase in price then you could “buy” with the “offer” price. This will be the higher of the two prices – the difference is the “spread” which we cover below.
If the asset rises in price, as you expected, then you can then “sell” at the “bid” price. You’ll have made a profit as long as the price rose by more than the spread.
Sell in a falling market
The next option is to “sell” a CFD on an asset that you predict will drop in value. This is done with the “bid” price. If your prediction is correct, you can then “buy” at the “offer” price. You will have made a profit if the value went down by more than the spread. However, if you are wrong and the price of the asset rises, you will suffer a loss.
Using margin and leverage
CFDs are a leveraged financial product. This means that you don’t need to put down the full value of your trade. You only need to outlay a small percentage of the value of an asset when you open a position, this is called the margin. The remaining value is borrowed from the CFD provider, so it’s essentially a loan.
Because of this, it’s entirely possible to lose more than your initial deposit when you invest in CFDs. It’s imperative to ensure that you’re fully aware of your exposure and use tools like stop-loss orders or stop-entry orders to reduce your risk.
like stop loss orders or stop entry orders which can help lessen your risk.
What is the spread? And how does it affect me?
CFD prices are always listed in pairs. There’s a different price depending on whether you want to “buy” or “sell”. There will be a difference between these numbers, sometimes quite small (known as a tight spread) and sometimes quite large (wide spreads).
It helps to look at an example. Let’s say that you want to trade a CFD and this is what you see:
SELL
BUY
6499.5
6500.5
The spread is the difference between 6499.5 and 6500.5, which is 1 point (that’s what it’s called, we don’t know why). Let’s say you think the value will go up, in this case, you’ll buy at the offer price.
Now, let’s say the value rises by 5 points over the space of a week. At that point, you’ll see this:
SELL
BUY
6504.5
6505.5
Both “buy” and “sell” prices have risen by 5. The spread is still 1 point. Now, if you want to exit your position, you need to make the opposite action you made before, in this case: “sell”.
When you sell, you don’t completely benefit from the rise of 5 points. As the spread is 1 point, you make a profit of 4 points. Depending on how much each point is worth, and how many contracts you’ve got, you can calculate your profit or loss.
What CFD trading strategies can I use?
There are two main approaches you can use when trading CFDs:
Going long. This means buying a CFD in the expectation that the underlying CFD will increase in value. You can then sell at a profit if your prediction is proved to be correct.
Going short. This strategy involves selling a CFD because you believe the underlying CFD will decrease in value. If this prediction is correct and the price drops, you can buy the product back in future at a lower price. You’ll hear the term used as a verb, such as “how to short the FTSE 100“
In either case, when you close the contract, you’ll make the opposite action to your original one. With this action, you want to gain the difference between the opening value of the contract and its closing value – whether that difference is up or down.
Example scenario
Let’s say that Dan has decided he would like to start trading CFDs. After hunting around for a trading platform that offers the features he wants, Dan decides that a company he has been monitoring, Joe Bloggs Enterprises, is set to experience a big jump in its share price, so he “goes long” and buys 4,000 CFDs at £5 each – that means a total contract value of £20,000.
The CFD provider requires a 5% margin in order to open a trade, so this amount (£1,000) is deducted from Dan’s account.
Happily for Dan, the shares jump a massive 10% from £5 to £5.50, which sees Dan gain close to £2,000, almost doubling his initial investment.
Now, let’s say that Daniella has also been monitoring Joe Bloggs Enterprises and believed that the share price was about to go down. She “went short” and sold 4,000 CFDs at £5 each. Like Dan, she has a total contract value of £20,000 and puts down a 5% margin for £1,000. As the shares have gone up, instead of down, as Daniella predicted, she lost her initial £1000 and owes a further £1000.
This is why CFD trading is risky. Leverage allows both Dan and Daniella to borrow £19,000 to purchase their contracts. They are both at risk of losing more money then their initial investment, which Daniella ends up doing.
In terms of trading strategies, there is a huge selection of approaches you can adopt. For example, you may wish to hedge a single stock by selling a CFD for every share you hold in a company. This can then offset any losses you sustain due to the fall in value of the underlying asset.
Another common approach is to engage in pairs trading with two historically similar stocks, such as shares in two banks. When the price of shares in one bank temporarily weakens against the price of those in another, you can then long the under performing stock and short the other one, taking the gamble that the spread between the two will eventually come closer together.
How do I compare CFD platforms?
Consider the following features when comparing CFD platforms:
Fees and charges. You may need to pay fees to a trading platform provider in order to trade CFDs and access markets. You’ll be charged for every trade you place and the trade will vary between providers, while you may also have to pay fees to access additional research data. Some platforms will charge interest on long CFD positions that are held open overnight, so make sure you’re aware of all the fees that may apply to your account. Most of the time, fees will be built into the spread.
Market data. What data does the trading platform make available about the market and the performance of underlying assets? Do you need to pay a fee to access this data?
Research tools. Consider the research tools available if you want to research companies, share prices and the performance of the market in general. These tools can help you make informed trading decisions.
Ease of use. Look for a platform that is easy and intuitive to use. Many platforms will let you open a demo account to sample their services, and these can be very useful when making your final decision.
Trading methods. In addition to trading online via your PC, can you lodge trades over the phone or through an app on your tablet or mobile device?
Margin requirements. In order to open a CFD, you’ll need to pay a margin – this is a percentage of the total value of the trade. Margin requirements vary between providers.
Margin calls. If you have an open trade that has lost money and there are not enough funds in your account to cover your debt, a CFD provider will make a margin call. While some providers will alert you to notify you of your margin call requirements, others will not and will instead place the responsibility on you to monitor your account.
What are the pros and cons of trading with CFDs?
Pros
You don’t have to worry about asset ownership costs
Because you are trading with leverage, you can start with a smaller amount of capital than if you were to trade the real underlying asset
Large financial profits is possible (but unlikely) when trading CFDs
You can enjoy the convenience of managing all your CFD trades at home with a user-friendly platform
Cons
Trading CFDs is a high-risk investment strategy
You can lose more than your original investment
Counterparty risk – the CFD provider may fail
Changing market conditions and the technical capabilities of the trading platform you use may mean you are unable to place trades at the time you wish
Using leverage means the possibility of magnifying your losses
Who should trade CFDs?
CFDs aren’t for the beginner investor. They are complex trading instruments and come with a high level of risk and a large percentage of users lose money trading CFDs. You need to ensure that you know the risks involved and that you are trading money that you can afford to lose.
Are CFDs a gamble?
Yes, and no. Gambling, in general, is about taking risks with the chance of a positive or desired outcome.
However, when it comes to tax, CFDs do not fall under gambling laws, which means you may have to pay capital gains tax on your profit. You can offset your losses against your profits, though, so if you make an overall loss then you wouldn’t pay tax on the gains you do make.
What are some of the risks when trading with CFDs?
Leverage
Leverage is one of the reasons why CFDs have such high risks attached to them. It essentially allows you to enter a position with only a small percentage of the value (called the margin). The remainder is borrowed from the CFD provider. For instance, if you buy £5,000 worth of ABC CFDs that have a margin of 5%, you only need to provide a margin of £250 to open the position. The rest of the value of the asset is covered by the CFD provider. However, the level of risk you are exposed to is identical to if you’d purchased £5,000 worth of shares at their full value. This means that any changes in the market will have a greater impact on the money you have invested than would be the case if you had simply bought shares in the traditional manner.
You’re not buying or trading the underlying asset
A CFD is a contract between you and the CFD provider. Rising or falling prices can result in a profit or loss for you, and it’s important to understand that you’re not buying the underlying asset. This means that you won’t receive dividend payments or have any ownerships rights or beneftis, as you won’t own the asset.
You can lose more than your original deposit
Because of leverage, your potential to gain a profit or suffer a loss is far greater than the amount you pay to open a position.
The most important questions about CFD Trading
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, you buy and sell the shares themselves.
Some of the underlying assets that you can trade CFDs on include UK and international shares, indices, commodities, foreign exchange and treasuries.
CFD trading is not recommended for casual investors. Because of the specialised 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, 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.
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.
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.
CFD 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.
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Zoe was a senior writer at Finder specialising in investment and banking, and during this time, she joined the Women in FinTech Powerlist 2022. She is currently a senior money writer at Be Clever With Your Cash. Zoe has a BA in English literature and a Diploma for Financial Advisers. She has several years of experience in writing about all things personal finance. Zoe has a particular love for spreadsheets, having also worked as a management accountant. In her spare time, you’ll find Zoe skating at her local ice rink. See full bio
Zoe's expertise
Zoe has written 154 Finder guides across topics including:
Trading CFDs carries a high risk, as you trade on real-time movement of the financial market. Give yourself an understanding of these risks with our guide.
How investors made money post-Brexit by shorting the FTSE.
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