CFD Trading
The buying and selling of Contracts for Difference (CFD)
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
What is CFD Trading?
CFD (Contracts for Difference) trading is increasingly popular with experienced investors, but anyone can try it. Most online trading platforms offer contracts for difference trading to their customers. It is a potentially high-risk trading strategy, but as long as you understand how CFD trading works, you can minimize your risk exposure.
The Long and Short of CFD Trading
CFD Trading is a type of derivative trading whereby you speculate on the rise and fall of prices of securities. You can trade a range of assets, including stock shares, foreign exchange, commodities such as gold and silver, and indices. CFD trading provides access to more than 10,000 global markets, and because every trade you make is leveraged, you do not need much capital to begin trading.
The difference between CFD trading and buying/selling a security is that you do not invest in the actual asset. Instead of buying or selling physical gold, for example, you merely speculate on whether the price of gold will go up or down.
How to Trade CFD Online
If you’re properly aware of the risks and want to start trading online, then you can open a CFD (Contracts for Difference) Trading Account with a company such as IG. Opening an account is free, however, there will be a charge on each trade by way of either a spread or commission.
IG has relatively low minimum contract sizes for new clients, although you will be required to put down a margin deposit. Once you start trading, you’ll find that trading CFDs can be an effective way to gain exposure to financial markets with less capital (but more risk).
Always consult a professional advisor before making any investment decisions.
Gold Prices and CFD Trading
Using gold as an example, we know that demand for gold began to fall in Q4 2017, so prices declined accordingly. In fact, prices dropped to less than $1,250 per ounce and some analysts forecast that gold will drop even further, potentially below $1,150 per ounce by the end of 2018. The expected decline is, in part, due to rising yields from U.S. investment bonds and strong U.S. tax reforms planned for 2018.
It is clear that gold prices can go either way, so it pays to follow economic data, in particular, U.S. interest rates, as they directly affect gold spot prices. If you decide that gold prices will rise, you should go “long,” which means buy. But if you suspect that gold prices are more likely to fall, you should go “short,” or sell.
Traders who guess market movements correctly make a profit based on multiples of the number of CFD units traded. However, if you get it wrong and the price movement goes against you, you will incur a loss.
Risks of CFD Trading
The attractiveness of CFD trading is that you only need to invest a small percentage of the full value of the asset you trade. Trading margins can be as low as 1%, so if you take a position worth $20,000, it may only require a $200 deposit – which is not a huge amount for an armchair investor.
If you have a profit margin, the money you earn will be based on the full value of the asset. This means that your profits can easily exceed the amount of the small margin deposit required to hold the CFD. However, if you get it wrong and take a loss, you can, conversely, end up losing more than your initial investment. Therein lies the primary risk of CFD trading. You may also be subject to holding costs if your positions are still open at the close of trading – i.e., held overnight. There will also be commission fees, depending on which trading platform or broker you use.
CFD trading can be a very useful – and profitable – strategy if you are looking to hedge investments in the underlying shares and assets the CFDs represent, especially if the market is volatile. Of course, you can also just trade CFDs outright, on their own. It’s not required that you already have other investments and solely use CFDs as a hedging investment. Just make sure that you fully understand the risks involved before you begin trading CFDs.
