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What are CFDs (Contract for Differences)?

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What are CFDs

Trading in CFDs is one of the most popular choices for investing in a wide range of markets around the world. Traders of all experience and knowledge levels are involved, and almost every top forex broker provides wide ranging access to CFD trading in a host of assets. But what exactly are CFDs?

First off, CFD stands for Contract for Difference. The clue is in the name here. CFDs are agreements between the trader and their broker to pay the difference between the opening and closing price of an asset.

The Basics of CFDs

CFDs essentially allow you a great deal of flexibility as a trader which you may not otherwise have had access to. This is particularly important in the modern age of discount brokers, and online trading. Platforms like eToro facilitate the trading of CFDs with great efficiency, convenience, and low cost. This opens up a number of new avenues for you as a trader.

  • The ability to access global markets in a wide range of assets with speed
  • Trading in everything from forex currency pairs to precious metals CFDs
  • Access to leveraged trading on assets
  • Low trading costs and high flexibility

CFDs have their basis in futures trading as another type of derivative being offered, and are becoming increasingly well-regulated. CFD trading through a top online broker you can expect regulation in place from some of the top bodies like CySEC, ASIC, the FCA, and others keeping you fully protected.

Differences Between Trading CFDs and Real Assets

One of the key points you should know about trading CFDs is that, when doing so, you are making a contract with the broker to pay the difference in price between opening and closing the position, but you are not actually purchasing the underlying asset. There are a number of advantages and some limitations when it comes to this type of trade. It will be up to you to decide if this is the best choice to fit your trading needs.

Receiving Dividends: This is something that you will want to double check carefully with your chosen CFD broker. Of course, if you are trading traditionally and owning the underlying asset you will receive a dividend when they are scheduled from the company. When CFD trading, some brokers may not pay out dividends. Many such as eToro will still credit the dividend to your account, though it is something you need to check on an individual basis.

Trading on Leverage: Trading CFDs with the majority of online brokers allows for you to trade on leverage. The amount of this leverage depends on the regulatory body which oversees your broker operations, but is capped at 30:1 on major forex currency pairs with CySEC for example. Such leverage access allows you to open larger positions, with smaller amounts of capital. This can increase your potential gains, though there is of course a heightened risk attached if the market moves against you.

Fees and Flexibility: The area of fees and trading costs is one where you can certainly benefit when it comes to trading CFDs. With traditional trading brokers, you are typically charged relatively high transaction fees, or other management fees based on your portfolio. When it comes to trading CFDs with major brokers like eToro, there are no such fees. In fact, you will only pay the spread with most online CFD brokers, and this is kept very competitive.

On flexibility, this can be particularly useful if you wish to “go short” on an asset. That is, to profit as the price goes down. Through traditional ownership, this is limited to trading in options, and some ETFs. CFDs make this much more possible. You can even open short positions from the outset. Advanced and user-friendly trading platforms can also help you to set stop losses to manage you risk in certain trades.

Things to do Before Trading CFDs

Naturally, there is always an inherent risk when you are trading any kind of instruments. The same goes for CFDs. There are though, a few steps you can take in order to set yourself up for success before you start to trade.

Choose a Trusted Broker: Just as with forex trading, or any other kind of trading, your broker choice is the first key. Here you want to choose a well-recognized name. Brokers like eToro are known all over the world, and for good reason. They offer a safe, and well-regulated trading environment as well as other things to help you along.

Research Trading Platforms: Many brokers will offer more than one trading platform that you can choose when CFD trading. These could be the well-known MT4, MT5, or cTrader platforms, or the brokers own proprietary trading platforms. The spotlight is on you to do some research here and choose the one which you find suits you best. Here are a few key points to think about when doing this:

  • Consider how many traders are already using a platform.
  • How many assets can you trade through this platform and broker. Are your favored markets available?
  • How user-friendly is the trading platform, and what support is available?

Build Some Knowledge: You do not have to be an expert on all things CFD trading, but it certainly does help if you can build some knowledge before you get started. This includes key terms, the basics or trading, and using your trading platform. Again, a lot of this can be accomplished through a top broker as many offer comprehensive education sections to keep you on track at various stages. It is another thing to look out for.

Opening a demo account is also a great way to tick all of the boxes above. These are offered by almost all CFD trading brokers, and can completely replicate the experience of live trading but without any of the risk. Through these accounts you trade with virtual currency, sometimes for an unlimited period time. Overall, they are a great way to build the knowledge, and expertise you need to start trading CFDs.

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Anthony is a financial journalist and business advisor with several years’ experience writing for some of the most well-known sites in the Forex world. A keen trader turned industry writer, he is currently based in Shanghai with a finger on the pulse of Asia’s biggest markets.

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