What is CFD Trading | How Does CFD Trading Work

CFD trading enables you to speculate on price movements in either direction. So while you can mimic a traditional trade that profits as a market rises in price, you can also open a CFD position that will profit as the underlying market decreases in price.

CFD Brokers

Contract for difference, or commonly known as CFD, trading is a type of trading that was originally developed in the early 1990s in London. This type of trading was used because it required only a small margin and at the time avoided the UK tax of stamp duty. In late 90s CFD trading was introduced to retail traders and became popularised by many UK companies that featured online trading platforms. The benefit to leverage any underlying instrument gained additional popularity to CFD trading and over the years this type of trading has been noting a significant growth.

How Does Trading With CFD Work?

CFD trading is a very interesting way of trading that’s much cheaper than, for example, traditional stock trading and it focuses on the price movement of a particular asset. The sole term contract of difference makes it clear that CFD trading is, in fact, an agreement between two parties that accept to exchange the difference between the opening and closing price of a contract. In CFD trading traders can profit no matter whether the price of an asset is falling or rising, since this trading focuses on the price difference only and not on the actual value of the asset of interest. Traders have two options in CFD trading and those are to buy and go long or sell and go short. CFDs have no expiration date and they can start making profit to traders the very same second they’re opened. CFDs are traded on margin and the minimum margin level has to be maintained by the trader at all times.

What are the Most Important Criteria for a Good CFD Broker?

Choosing a good CFD broker is as important as learning how CFD trading works. Without a reliable trading operator that takes a good care of its customers and provides a stable platform, traders won’t be able to feel safe, easily open trades and have an overall pleasant experience. Thus, here are the main criteria for finding a top broker.

If you want to be sure that your chosen CFD trading broker is keeping your information confidential, providing a safe trading environment and offering a good service you should find a broker that’s licensed and regulated. In order to obtain a licence from a reputable regulating body CFD trading operators have to meet high standards set by regulators. Therefore, whenever you find a broker that has been approved by the UK’s FCA, Cyprus’ CySec, Germany’s BaFin or any other regulator, you shouldn’t worry about things such as safety, security and fairness.

Also a very important criterion for selecting a CFD trading broker is the way it handles clients’ funds and data. This is one of the factors that are heavily affected by licensing because, for example, the FCA requires all licensees to carry out daily Financial Resource calculations to make sure the operator has adequate regulatory capital at all times. Additionally, its regulated brokers have to segregate customers’ funds from the company’s own money by placing them in a separate account in a stable financial institution. This way, in case the company falls apart, all traders’ funds will be safely stored on a separate account and won’t be used for paying off any possible company’s debts. Besides safety of traders’ money, top brokers secure traders’ data as well. The most commonly used, and most effective, ways of doing so is use of latest encryption technology and a strict policy of not sharing such information with third parties.

When trading with CFD, traders have to make a minimum deposit, pay attention to commission, spreads, max leverage and any other factors that let them know how much money they have to invest and spend in order to trade at that particular site. The minimum deposit amount at CFD brokers usually varies from $5 to $500, while the commission is most commonly 0% or 0.1%. The spread can be either fixed or not and its value often goes between 0.5 pips and 6 pips. Additional important information about costs and fees at CFD brokers are inactivity fees and money transaction processing fees. Obviously, the less fees the better.

Trading with CFD is an enormous field of possibilities, especially if you choose the right broker. Some CFD trading sites can boast with a truly amazing number of trading markets and underlying assets such as indices, commodities, equities, currency pairs and etc. By making a smart choice while selecting a CFD broker, you can ensure that you will never miss a good trading opportunity since you’ll gain access to hundreds, if not thousands, of markets. All CFD brokers tend to highlight their main strength when it comes to their trading offer and thus some brokers boast with over 800 equities, others with over 5,000 products and there are even brokers that give you the chance to trade on over 10,000 global markets. Alongside the assets, it’s important to check the leverage that can be anything from 1:10 to 1:888 or even more. Higher leverage means higher risk, but also higher profits too.

CFD trading wouldn’t be possible unless there are trading platforms. Therefore, it’s easy to conclude that the software featured at CFD brokers is especially important. There are three basic types of trading platforms and those are ones that have to be downloaded, web-based platforms and mobile platform. However, the exact type of a CFD platform can be, for example, MetaTrader 4, ETX TraderPro, EXT Trader and etc. So, what makes a good trading platform? The answer is pretty simple, a good platform rarely crashes as well as it’s easy to use, user-friendly and features lots of trading tools. Having the option to trade on the move is only an additional plus that makes it possible for traders to keep track of their contracts or open new trades wherever they are. Mobile trading platforms also can be either downloadable native apps or web-based applications.

No matter if you are a rookie CFD trader or an experienced one, it’s always the best to try a particular trading platform for free before actually invest money. Hence, as one of the very important criteria in choosing a broker we have listed demo account and learning material. Demo account works the same as a real money CFD trading account; however, when trading via demo account users are not asked to make a deposit or invest real money. This gives them a chance to learn how everything on that particular platform works without risking their initial investment. The learning materials, similarly, help traders to learn the basics of CFD trading and thus get well prepared when the real money action starts. Learning materials can include simple step by step guides, e-books, online seminars, CFD glossary and etc. The more learning tools there are, the better.

Who doesn’t want free cash that can be invested and possibly generate profit? Nobody, the answer is nobody. CFD brokers are well aware of this and thus they offer various bonuses and promotions to their customers. Generally, there are two types of bonuses that traders can claim at CFD trading operators and those are no deposit bonuses and deposit bonuses. The first ones are rarely offered and they usually are very low (between $5 and $30). The second type, however, is a common thing among CFD brokers and thus traders can expect generous bankroll boosts that sometimes can be $5,000 or more. The match percentage usually depends on the operator’s bonus policy and on the deposit amount. Nevertheless, often featured match bonuses commonly vary from 20% to 60%. These bonuses can be exclusive welcome offers, reload bonuses or special limited-time promotions.

The last thing you should have in mind when choosing a CFD broker is the customer support it offers. This service is usually the last thought we have until there’s a problem or an issue. In order to be sure that if you ever find yourself in a situation to need assistance you will get it within minutes, it’s the best to join brokers that offer a 24/7 support. Another point of interest is the list of contact options that should include live chat, phone and e-mail. It’s also smart to check if the phone line is toll free.

Pros and Cons of Trading with Leverage

CFD trading is trading with leverage and those familiar with this concept are well aware that it comes with both pros and cons. These positive and negative aspects of trading with leverage are the sole factors that should help you decide whether this way of trading suits your bankroll and needs. So, the first and most important pro of trading with leverage is the extremely high return rate. However, high profit always comes with high risk and that brings us to the main con of trading with leverage, which is a potentially catastrophic loss. Another pro of this way of trading is being able to get the minimum lot size with fewer own capital. However, once again, the risk of a bad trade to eat up a significant part of your margin remains. Trading with leverage is recommended only to experienced traders that are 100% aware of the risk they’re taking.

What I Have to Know about the Margin Call?

All CFD traders are required to maintain a certain amount of margin which is predetermined by the online broker they’re registered with. This margin usually goes between 0.5% and 30%. The margin associated with CFD trading usually can be initial or variable; whatever the case, maintaining the margin is crucial because if a trader fails to do so s/he may get a margin call. To find out whether you should pay a margin call you need to add up all margin requirements for all open positions on your CFD trading account. In case the cash on the account and the total profit or loss of your open positions is less than the margin requirement, you will have to pay the margin call. If you don’t pay the margin call, you’ll have to quit the option. Therefore, if you’re not quite sure whether you can afford to open a contract or not, it’s the best to contact your CFD broker first and require all information you need.

Do I have to Pay Taxes on Winnings?

Unlike spread betting which is exempt from capital gains tax, CFD winnings aren’t exempt and thus traders have to pay taxes on them. However, this is not such a bad thing because CFD losses are deductible against tax too. This means that any losses can be offset against profits for tax purposes and that’s actually a very good thing. Naturally, the exact CFD tax policy may vary from one country to another because different jurisdictions have different tax rules. The specific tax advantage mentioned before is a phenomenon found in the UK and Ireland, while in Finland, for example, the losses cannot be deducted.

Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 70.52% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Copy-trading services imply additional risks to your investment due to nature of such products. If the risks involved seem unclear to you, please apply to an outside specialist for an independent advice. Trading CFDs on virtual currencies implies additional risk to your investment due to the nature of such products.

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CFD trading enables you to speculate on price movements in either direction. So while you can mimic a traditional trade that profits as a market rises in price, you can also open a CFD position that will profit as the underlying market decreases in price.

Trading a CFD means entering into a contract to exchange the difference in the price of an asset from the time your position is opened to when it is closed.

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