DEFINITION

Contract for difference trading

A contract for difference (CFD) trade is where you speculate on whether the price of a market will increase or decrease in the short-term. If you’re correct, your profits are determined by the price difference between your opening and closing trades. This price movement also determines how much money you lose if you turn out to be wrong.

CFD trading is popular as you don’t need to own the thing you’re trading on. For example, you could trade on the movement of Apple’s stock price without having to physically buy the shares. This allows you to trade on margin so there’s less financial commitment in this sense, which obviously has its appeal. This also means you have the option to trade and profit from markets that are falling in price as well as those that are rising.

However, the way CFD trading works means it can be tempting to overtrade. The danger is that losses can be magnified significantly compared to the amount of money you need to open the trade. What’s more, you have no say in the currency you’re trading in, which may result in additional costs and complications.

For these reasons, we think CFD trading is better for experienced traders, rather than those just starting out on their trading journey. But for those who have already learned the ropes, CFDs can undoubtedly enrich your trading strategies.

Is CFD trading right for you?

Before you dive straight in, we want to make sure you know what’s what. CFD trading certainly isn’t straightforward and there’s confusing terminology involved too. So, it’s probably not the best way for those new to trading to learn the ropes.

If you want a flying start in trading, we think you’d be a perfect fit for Trade Nation. We’re all about helping beginners get to grips with the mechanics of trading. We also work hard to get rid of the complex jargon to make it easier to understand. But if you’d like to know more about CFD trading, let us explain everything you need to know and then you can then make that decision for yourself.

Alternatively, try our free trading simulator. It allows you to practice trading and learn the essentials along the way. Ideal for beginners, it’s free and there’s no login required.

Things you might hear CFD traders say

“Going long” & “going short”

Going long means you buy CFDs as you believe prices will rise. Going short is the opposite: you sell CFDs as you expect prices will fall.

How does CFD trading work?

Every contract has a sell price and buy price, which are respectively slightly lower and higher than the current market price. The difference between the sell and buy prices is called the spread and this reflects how much it will cost you to make the trade.
If you reckon prices on a market are going to rise, you buy a number of CFD contracts (also called units). On the flip side, you sell these contracts if you think prices will fall. It’s possible to trade CFDs on lots of financial markets like , commodities, stock indices, forex, and shares.

There are no fixed expiry dates on CFD trades so in order to close your position, you have to place a trade in the other direction. For example, if you bought 500 contracts initially, then you would close this position by selling them. It’s also worth noting that as you are trading on margin, you will have to pay interest every time you keep your trade open overnight.

EXAMPLE

Let’s look at a CFD trade on the US 500 index

In this example, the CFD provider has stated that 1 CFD is worth $1 per pip, and a pip is equivalent to 1 full US 500 point. If the US 500 moves by 1 point, you would make or lose $1.

The sell and buy prices on the US 500 are 4,251.0 - 4,251.5. You believe prices are going to rise so you buy (or go long) 2 CFDs at 4,251.5.

The total value of your trade is calculated by multiplying the price you have traded at, by the number of $ per pip you have bought:

4251.5 x $2 = $8,503

There is a 5% margin charge for a trade on this market, 5% of $8,503 is $425.15 so this is what you need in your account to make the trade.

How a trade might play out

A WINNING CFD TRADE

You're correct and prices do increase. You close your position when the US 500 quote is 4,305.0 – 4.305.5 selling 2 CFDs for 4,305.0

Calculate the difference between the opening and closing trades, then multiple by the number of CFDs to see your profit.

4,305.0 - 4,251.5 = 53.5 points

53.5 x 2 CFDs = $107.00

A LOSING CFD TRADE

Unfortunately the market has moved against you and you have to sell 2 CFDs to close your position.

Now the US 500 quote is 4,188.0 – 4,188.5and your loss is calculated like this:

4,188.0 - 4,251.5 = 63.5 points

-63.5 x 2 CFDs = -$127.00

How a trade might play out

A WINNING CFD TRADE

A LOSING CFD TRADE

You're correct and prices do increase. You close your position when the US 500 quote is 4,305.0 – 4.305.5 selling 2 CFDs for 4,305.0

Calculate the difference between the opening and closing trades, then multiple by the number of CFDs to see your profit.

Unfortunately the market has moved against you and you have to sell 2 CFDs to close your position.

Now the US 500 quote is 4,188.0 – 4,188.5and your loss is calculated like this:

4,305.0 - 4,251.5 = 53.5 points

53.5 x 2 CFDs = $107.00

4,188.0 - 4,251.5 = 63.5 points

-63.5 x 2 CFDs = -$127.00

This sounds a bit like spread trading, doesn’t it?

CFD trading involves a spread, making it quite like spread trading which is what we also offer here at Trade Nation. Both CFDs and spread trades allow you to speculate on financial markets, but spread trading is arguably the most straightforward way to do this.

CFD vs spread trading in brief

With CFDs, the currency you trade in depends on the specific market. If you normally use GBP but the trade you want to make is valued in USD, then your profit or loss will be in USD too. So you’ll need to consider how this will affect how much you could win or lose. Currency exchanges will be involved too, adding to your overall dealing costs.

Spread trading, on the other hand, allows you to deal in your preferred currency, so you always know where you stand. You can also choose the amount per point yourself, given certain minimum sizes. This gives you total control over how much you’re trading. It also means it’s much easier to calculate your profits or losses.

With CFD trading, the amount per point is decided by the provider.

For example, the provider could say 1 CFD is worth $10 per pip, with a pip being worth 1 full US 500 point, but they may also say 0.1 of a point is a pip.

CFD TRADING IS TRICKY, RIGHT?

We haven’t mentioned the hidden costs...

Still feeling a little confused? Don’t worry. CFD trading can be very complicated, especially if you’re new to these financial markets.

It can also be more expensive than you think. We’ve mentioned that you may need to convert profits into your currency of choice to actually withdraw it. Guess what? Some providers will charge you a hefty premium for that, and that’s on top of the fees you’ve paid to make the trade in the first place.

It’s also worth noting that the spread on CFD trades can move depending on the underlying market. The spread determines how much it will cost to make the trade and this isn’t fixed with CFDs. So you’ll never be certain what your transaction rates are. These could add up to be more than you expected. On top of this, you often have to pay a commission fee on CFDs.

It doesn’t need to be this way though

There’s a much better way to trade. What if we said you could avoid secret expenses and know all the fees up front?

Here at Trade Nation, we’re always completely transparent about charges so you’ll never be taken by surprise. And, as we offer spread trading, you can speculate on the markets in a currency of your choice. Plus, all our spreads are fixed, which means your transaction rates will never unexpectedly change.

If you want a straightforward way to trade free from hidden and unfair charges, why not join the Trade Nation community? We’re all about making trading honest and easy to understand, and we’re with you every step of the way!

The final word from David, Senior Market Analyst

Why trade CFDs?

Here’s 3 reasons why you should trade CFDs:

1. CFD traders can hedge against declines in their share portfolio by short selling CFDs against the securities they physically hold. In this way, they can protect themselves from falling prices without incurring the costs of closing out their physical shares.

2. CFD trading is leveraged. This means you only have to put down a small percentage of the underlying value of a trade to control all of it.

3. CFDs allow you to trade multiple asset classes from one account.

A Trade Nation CFD account provides access to well over a thousand different markets from our trading platform. This means you can centralise your speculative and hedging activity. Running your own account from one platform, without having to instruct a broker to act on your behalf, and monitoring market movements in real time, are all major advantages of having a CFD account with Trade Nation.

Join our nation of traders

Financial spread trading comes with a high risk of losing money rapidly due to leverage. You should consider whether you understand how spread trading works and whether you can afford to take the high risk of losing your money.