What is CFD Trading?
For traders who seek to gain exposure to a wide variety of financial assets without owning them, Contracts for Difference or CFDs may be a good option. So what are CFDs exactly, what is the meaning of CFD, and what else should you know before trading CFDs?
This video demonstrates the features of trading CFDs with Plus500, including trading with leverage (i.e. opening a position with a fraction of its total value), and low minimum deposits, as well as how to open a sell (short) position, which is just as straightforward as opening a buy (long) position.
CFD Meaning: What is a CFD?
'Contracts for difference', or just CFDs, are tradable derivative products that follow the prices of global financial markets. A CFD allows you to obtain direct exposure to an underlying asset, for example, Gold, UK 100, or EUR/USD, without owning the underlying asset. You will make gains or incur losses as a result of price movements in the underlying asset.
Brief History and Development of CFD Trading
CFDs seem to date back to the 1990s whereby Brian Keeland and Jon Wood, two UBS Warburg workers, are credited for their invention. At the time, CFDs were usually used by hedge funds.
After a while, in the late 1990s, CFDs became available for retail clients through online trading systems that allowed trading CFDs on the London Stock Exchange. The first company to do this was called GNI (Gerrard & National Intercommodities). CFDs then became available across various markets like indices, stocks, and forex in the UK and then expanded to other countries like Australia and the Eurozone.
Nowadays, companies such as Plus500, offer CFD trading services on a variety of financial markets through online intuitive trading platforms.
How Does CFD Trading Work?
CFDs are agreements between two entities, usually a trader and a CFD broker, to trade the difference in the price of an underlying financial instrument from the opening of the contract until it is closed.
In terms of profits and losses, while trading CFDs, if the markets follow traders' predictions, their position will be profitable. Conversely, if the market moves against their prediction, the traders experience a loss.
Eventually, the traders get these profits or realize the losses when their position is closed after they sell the contracts they initially bought.
For example, if you believe the value of a stock, such as Apple, is going to increase, you can open a Buy CFD position (also known as "going long") with the intention to close the CFD position at a higher value. The difference between the price you opened and the price you closed the CFD position equates to your potential profit or loss, minus any relevant costs. If you think the value of a stock, such as Meta, is going to decrease, you can open a Sell CFD position (also known as "going short") at a specific price, with the intention to close it at a lower price. Your profit or loss is calculated based on the difference between these opening and closing prices.
What Are the Possible Advantages of CFD Trading?
- In both Buy and Sell scenarios, you do not actually own the underlying asset. This means that you can diversify your portfolio without having actual ownership of the asset. In other words, traders can potentially benefit from rising or dropping price swings without directly owning the assets.
- Shorting: Short selling is also available – opening Sell positions is just as straightforward as opening Buy positions.
- Low minimum deposit requirement – a relatively small amount of money is required to start trading CFDs in stocks, forex, commodities, and many more financial instruments.
- No storage costs: Some CFDs, like commodity CFDs, do not require that you pay storage costs, unlike other types of commodity contracts because by trading CFDs you do not own the underlying assets such as gold or oil (please note that other fees like overnight fees, etc may apply depending on the CFD broker).
Disadvantages of CFD Trading
Before trading CFDs, there are a few more factors traders may want to take into consideration:
- High risk: CFDs are considered risky due to market volatility. As such, traders should consider educating themselves and/or seeking professional advice on how CFDs work before trading CFDs. Plus500 offers free-of-charge trading materials ranging from how-to videos to articles in order to help traders make informed decisions and navigate the markets better. Check out Plus500’s Trading Academy to learn more.
- Leverage: while leveraged trading may be profitable if market prices are in line with traders’ predictions, it can also act as a double-edged sword. This is because leverage can magnify gains but similarly, can also magnify losses.
What is Leveraged Trading?
Leverage is a concept that enables you to multiply your exposure to a financial instrument without committing the whole capital necessary to own the physical instrument.
When trading CFDs, you are engaging in leveraged trading, which means you don’t need to commit the full amount of capital for your trade value. For example, with a leverage of 1:10, your initial margin requirement for this particular CFD is 10%. This means you need to deposit $100 to gain a notional exposure of $1,000. Accordingly, any potential profits or losses will be multiplied. Likewise, a leverage of up to 1:30 means that with $100 you can gain the effect of $3,000 capital. Accordingly, any potential profits or losses will be multiplied.
What is Margin in CFD Trading?
Margin is the amount of capital that you need to have in your trading account to open and maintain your CFD position(s). These funds are required as collateral in order to cover any potential losses you may incur.
There are two main types of margin:
- Initial Margin - to open a new position, available account equity must exceed the initial margin level requirement.
- Maintenance Margin - to keep a position open, your available equity must exceed the maintenance margin level at all times. If the required margin level is not kept, your position(s) will be closed by a margin call regardless of its Profit & Loss (P&L).
The margin requirements vary from one financial instrument to the other and are specified in each instrument's details. You can learn more about margins in our Trader’s Guide video on “Margin Requirements.”
What is the Contract Length of CFDs?
Although the contract length may vary depending on the CFD broker and platform, generally speaking, a CFD does not have a pre-set expiration date like Futures or Options. Instead, CFDs are generally considered open-ended which means traders can close their position as long as the contract is tradable and available for trading. Nonetheless, traders should keep in mind that while most CFDs are open-ended, some, like Options CFDs, actually have an expiration date.
What Assets Can You Trade with CFDs?
CFDs allow you access to a wide variety of markets including Indices like the Nasdaq (US-TECH 100) and the S&P500 , Forex pairs like the EUR/USD and GBP/USD, Stocks like Microsoft (MSFT) and NVIDIA (NVDA), and Commodities like Natural Gas (NG), and Crude Oil (CL). In addition, with CFDs, traders can trade ETFs, Futures, and Options on Futures on various market instruments.
*Availability is subject to the regulator.
Are CFDs Available in the US?
CFDs cannot be traded in the US due to the fact that they are Over-The-Counter (OTC) products that are prohibited under US regulations.
However, US traders who want to trade with Plus500 can do so by trading Futures contracts on the Plus500 US platform.
Managing Risks when Trading CFDs
Some of the ways through which traders can mitigate risk while trading CFDs include using risk management tools like Close at Profit, Stop Loss, Guaranteed Stop, and Trailing Stop.
- Close at Profit/Stop Loss:
This risk management tool allows you to decide when to close your position (when it reaches a certain price) to either protect your gains or minimize your losses.
- Guaranteed Stop:
By doing this, you are placing an absolute limit on your risk of significant losses. This, in turn, protects you from price swings, even if the instrument’s prices move significantly against your position.
- Trailing Stop:
This order secures profits by closing your position automatically if the price changes direction.
To get a better understanding of how risk management tools work, go to our Trading Academy article on Risk Management.
In addition to risk management tools, traders may also refer to trading charts in order to understand past prices better. To learn more about trading charts watch Plus500’s Trader’s Guide video on “Types of Trading Charts.” Regardless, it is important to keep in mind that past price patterns do not indicate future results.
Why Trade CFDs with Plus500?
If CFD trading interests you, then you may want to consider trading CFDs with Plus500. With Plus500 you get access to the following:
- Zero commissions and attractive spreads (please note that other fees may apply).
- Free and unlimited demo account that allows you to practice CFD trading in real market conditions for free.
- Straightforward order executions and withdrawals.
- Free access to risk management tools and trading charts.
- Free educational materials like informative and news articles, how-to trading videos, and trading FAQs.
Regulations and Operating Licenses
When choosing a CFD platform, it is important to keep in mind the regulations and operating licenses of the CFD service providers.
Plus500 is authorized and regulated by the FCA, CYSEC, ASIC, ISA, MAS, FSA, EFSA, and DFSA. You can also read further information about Plus500’s operating licenses and subsidiaries here.
Final Thoughts on the Future of CFD Trading
Since their inception in the 1990s, CFDs have certainly made an impact on the markets as a whole and on traders. Given the fact that nowadays more and more CFD platforms are emerging, it feels that CFDs are currently here to stay.
All in all, CFDs are risky assets but can also provide traders with a plethora of possible advantages including access to a wide range of market instruments for lower costs. If you feel that CFD trading may be the right fit for you and understand the risks involved, then Plus500’s advanced fintech platform may be a good choice for you.
CFD Trading FAQs:
What do CFDs mean?
CFDs, or Contracts for Difference, are financial derivatives that allow traders to speculate on the price movements of various underlying assets without actually owning the assets themselves.
Are CFDs leveraged?
Yes. CFDs are leveraged, meaning traders can trade a larger position with a relatively small amount of capital. While leverage can magnify gains, it can also amplify losses, depending on the price movements of the underlying asset. You can read more about leverage in our FAQ section under the “What does “Leverage” mean?” question.
How can I trade CFDs?
You can trade CFDs with a regulated provider like Plus500. To trade CFDs with Plus500, you need to open a trading account, click on the “Trade” tab, and open a buy or sell position depending on your goals. Alternatively, you can open a demo account and practise trading in real-market conditions for free until you feel ready to trade for real. To learn more about how you can trade CFDs with Plus500, watch our free Trader’s Guide video on “How to Trade With Plus500.”
Do CFDs have an expiration date?
Most CFDs do not have an expiration date. However, some markets, like Futures and options, may have an expiration date.
Are CFDs risky or safe?
Like other leveraged derivatives, CFDs are certainly risky due to the unexpected nature of the markets as well as their leverage. Accordingly, to mitigate these risks, traders can educate themselves on how CFDs work and use risk management tools to limit potential losses. In addition, traders may want to closely monitor market conditions, events, and news.
Are CFDs legal?
CFDs (Contracts for Difference) are legal financial instruments regulated by various frameworks for CFDs overseen by various regulatory bodies. For example, CFDs are regulated by the MiFID II Directive, which provides a regulatory framework for financial markets in the EU. Plus500 offers CFDs worldwide through its licenced subsidiaries in Australia (ASIC), the UK (FCA), Cyprus (CySEC), Singapore (MAS), Israel (ISA), Seychelles (FSA), Estonia (EFSA), and Dubai (DFSA).
How are Futures and CFDs different?
One of the main differences between Futures contracts and CFDs is that Futures have a predetermined date and price and traders get ownership of the underlying asset, whereas CFDs do not grant ownership of the underlying instrument. In addition, when trading CFDs you can buy or sell them at any time or price.
Can CFDs be traded overnight?
Yes, CFDs can be traded overnight. However, trading overnight is usually accompanied by a fee. You can read about the different types of CFD fees in our Fees & Charges section.
How do I calculate the margin in CFD trading?
The CFD initial margin is calculated as a percentage of the total value of the CFD position. You can learn more about calculating margin in our FAQ titled “How do I calculate my Margin requirements?”
How are CFDs and traditional investing different?
Traditional investing, such as buying shares or investing in a fund, gives the trader direct ownership of the underlying asset and is more suitable for long-term trading, whereas CFDs do not grant ownership of the underlying asset. Instead, when trading CFDs, traders are essentially speculating on the rising or falling prices of the underlying asset (depending on their position) without actually owning it. This makes CFDs more appropriate for short-term trading for purposes such as hedging and speculation.
What is a CFD issuer?
A CFD issuer is the entity that provides the platform needed to trade CFDs. Plus500, for example, is considered a CFD issuer.
What are CFDs’ trading hours?
CFD trading hours differ based on the underlying instrument. For example, Index, Commodities, and Forex CFDs are traded 24 hours a day, 5 days a week, while Share CFDs are traded based on the relevant stock exchange’s trading hours. Keep in mind that the trading hours are displayed under the instrument’s properties.
Who are CFDs suitable for?
CFDs may be suitable for certain knowledgeable traders with a high-risk tolerance who can afford to lose their money, such as day traders, traders who seek leveraged trading, and those seeking access to a wide variety of markets for less capital and without having to own the underlying assets.
What do long and short mean in CFD trading?
If you decide to "go long," it means that you are opening a position for buying a particular asset with the expectation that its value will increase in the future. On the other hand, if you choose to "go short," you are opening a position for selling an asset with the anticipation that its value will decrease over time.
What can affect CFD prices?
The price of a CFD is derived from the price of the underlying asset which can be affected by Monetary policies set by Central Banks, company and industry financial statements, news and current events, supply and demand, and other external factors.
Plus500 does not claim to be an official academic institution that has received recognition from any country/government.
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