Introduction to CFD trading
What are CFDs?
A CFD stands for Contracts for Difference. When you trade CFDs, you don’t physically own the underlying asset, instead, you are speculating on the price movement of that asset (financial instrument). This means you can take advantage of prices move up or down in value, on thousands of global financial markets including currencies, indices, commodities and more. This arguably gives you greater trading freedom.
CFDs are a leveraged financial trading product, which essentially means you are trading on margin. Leveraged trading allows an investor to put up only a small upfront investment in order to open a much larger position. This means rather than paying the full value of the position, you only need to pay a percentage of the position, which is called ‘initial margin’. Trading CFDs increases your buying power, maximising your trading capital and potential profits. However, it is important to note that leveraged trading also exposes you to more risk, as losses can be equally magnified if the trade goes against you, due to the fact they would be based on the full value of the position. It is possible to lose your entire investment, if you are a Retail client. Professional clients can lose more than their deposits and they may be required to deposit additional funds to cover their losses.
Think of leverage as a broker enabling you to make the most of your trading capital.
For example: Trader ‘A’ deposits £100 into a trading account in order to trade a CFD product with 20:1 leverage. With that £100, Trader ‘A’ is able to open a trade with an exposure of up to £2,000.
What is a lot?
CFDs are traded in what is called ‘lots’. A lot is the size of your CFD trade. When trading CFDs, the value point per movement of one lot will vary between each market. For example, 1 lot of the UK100 is equivalent to £1, whereas 1 lot of France40 is €1, and 1 lot of gold is 100 ounces.
Example 1: If you trade 1 lot of our UK100 contract, you are trading the equivalent of £1 for each point movement. This means for every point the market moved in your favour (the direction of your trade), you would gain £1, and for every point the market moves against you (the opposite direction), you would lose £1.
In gold, $1 (USD) movement in the price, is equal to $100 for every 1 lot.
Example 2: A trader buys 1 lot of gold at $1200. The price moves to $1201, which would make him a $100 profit. If the price moved to $1199, he would make a $100 loss.
What types of CFDs can you trade?
CFDs can be traded on thousands of global financial instruments, including:
- Forex (currency) pairs such as EURUSD, GBPUSD, USDJPY and a range of minor and exotic currencies
- Indices including the UK100, Germany30, US500 and Japan225
- Energy and commodities such as gold, silver, oil, natural gas and coffee
- Individual shares (equities/stocks) traded on the stock exchanges
Difference between CFD trading and forex trading?
One of the obvious differences is that forex trading refers purely to trading in the forex market (currency pairs). CFD trading involves different types of contracts, including index, commodity and share CFDs.
However, there are a number of major similarities between forex trading and CFDs:
- A trader will never actually own the underlying asset, which means they can buy or sell any financial instrument.
- They can both be traded on the same platform (for example MT4).
- Both rolling spot forex and CFD trades are subject to rollover rates, which in FX are also known as “swap charges” (also known as financing charges). This is essentially a charge for holding a position open overnight and is linked to the interest rate of the underlying currency.