Thinking of trading the financial markets? You might want to consider utilising contracts for difference (CFDs).
These financial derivatives are an increasingly popular trading instrument, allowing you to speculate on the market price of an underlying asset, without having to physically own it.
Imagine being able to trade the market price of oil without needing an oil refinery to store it. Or perhaps you might want to trade the value of the pound against the U.S. dollar without needing a safe to house thousands of pounds of cash? Trading CFDs online gives you the flexibility to take positions on rising or falling markets across equities, forex, commodities, indices and more.
Within this guide, we’ll explain the mechanics of online CFDs, the benefits, as well as the risks of CFD trading to give you the wider picture.
What are CFDs in Trading?
Our CFD definition describes them as financial agreements between traders and brokers to exchange the difference in the value of an asset from when the contract opens to when it’s closed.
This means you can speculate on upward and downward price movements of a market, without owning the underlying asset.
Let’s take a look at a basic CFD trading example:
- You anticipate that Microsoft’s annual trading update will be better than expected, so you open a buy (long) CFD position on Microsoft.
- If Microsoft’s share price rises as predicted, you’ll profit from the difference between the price when you opened the CFD position and the price when you closed it.
- Equally, if the price fell below your long CFD position, you’d have to close it for a loss.
It’s the role of CFD brokers to facilitate these trades by providing platforms and tools to make the right decisions. Most will charge commissions or spreads on each CFD position you open.
Another crucial talking point on CFDs is leverage. Leverage allows you to amplify the value of your position while depositing only a small fraction of the position. The deposit needed to hold the position is known as the ‘margin’.
For instance, a CFD broker may offer 1:10 leverage, allowing you to open trades worth £10,000 using just a £1,000 margin. This means your potential returns – and losses – are magnified, so leverage should only be used when you’re confident in your CFD trading strategy.
How do CFDs Work?
CFD traders open positions by predicting whether the underlying asset’s value will rise or fall. If they feel it will rise, they will open a long (buy) position. If they feel it will fall, they will open a short (sell) position.
Trading positions can be manually opened and closed at any time. Alternatively, you can use your CFD trading software to automate the process using stop-loss and take-profit orders which frame your potential profit or loss.
A key feature of how CFDs work is leverage, allowing you to control larger positions in the market with smaller amounts of capital upfront, known as the margin. For instance, you can trade major forex pairs like EUR/USD with anything from 1:50 to 1:200 leverage, depending on your lot position.
Types of CFDs
Using CFDs, you can speculate on a wide variety of asset classes, without having to own them yourself. Let’s run through the CFDs available with reputable, licensed CFD brokers, opening the door to participate in all the major financial markets.
Forex CFDs
Forex CFDs are a popular derivative for speculating on the price movements of major, minor and exotic forex pairs. For example, you can trade forex CFDs on GBP/USD when the UK and U.S. make key decisions on their respective interest rates.
If you have a particular view on the economy of an emerging market, exotic forex CFDs may also take your fancy. Just bear in mind that minor and exotic forex CFDs tend to incur wider spreads and lower liquidity than the likes of EUR/USD and GBP/USD.
Stock CFDs
What’s great about trading stock CFDs is that you can ‘buy’ the share price of a company you like and profit if its price rises, without having to incur stamp duty.
There’s nothing stopping you from trading the market value of the so-called ‘Magnificent 7’, including Apple, Tesla and Amazon. Stock CFDs also allow you to take positions on a share price falling as well as rising, making it possible to trade profitably in bull and bear markets alike.
When you trade stock CFDs with online brokers like ActivTrades, there’s low fees and no need for direct stock ownership.
Commodity CFDs
As a novice retail trader, you might’ve thought that profiting from raw, precious materials like gold, oil and natural gas were out of your reach. However, commodity CFDs allow you to open long or short positions on all types of hard and soft commodities, including agricultural products like wheat and sugar.
In fact, commodity CFDs are especially useful as diversification tools for wider trading portfolios since you get exposure to global markets and can respond to macroeconomic trends or supply-demand shifts.
Index CFDs
CFD indices allow you to speculate on the market moves on a major stock market index like the S&P 500 or the FTSE 100. Instead of buying actual shares in an index fund, you just trade the price movements, profiting from the difference between the opening and closing price of your CFD.
You can go long or short with indices CFDs, allowing you to trade indices which may be experiencing an economic downturn too.
Cryptocurrencies
Depending on where you live, it may also be possible to speculate on the price of cryptocurrencies using CFDs too. This means you can trade the market value of Bitcoin and major altcoins like Ethereum and Ripple. Crucially, you don’t need to worry about self-custody of your cryptoassets, since you never own the underlying asset.
Some traders will use leverage to take advantage of short-term price volatility on Bitcoin and other cryptos experiencing bursts of liquidity.
ETFs
Exchange-traded fund (ETF) CFDs also allow you to speculate on the price movements of ETFs without having to physically own them. ETFs typically include a basket of assets, like stocks or commodities, giving you diversified exposure to the financial markets.
ETF CFDs also give you exposure to broader sectors or indices without substantial capital requirements.
Bonds
Bond CFDs give you the opportunity to speculate on the price movements of government and corporate bonds without having to own the underlying bond.
Trading the price of bonds using CFDs gives leveraged exposure to fixed-income markets, allowing you to profit from rising or falling bond prices, influenced by interest rates, inflation expectations and macroeconomic data.
Why Trade CFDs Online?
What are the advantages of CFDs and why should they become an important part of your trading arsenal?
- Flexibility and accessibility
- Trading CFDs gives you the freedom and access to speculate on a host of asset classes. At ActivTrades, our clients get access to seven asset classes, ranging from forex and equities to commodities and bonds.
- Trade with reduced capital
- CFDs trading is possible even for those retail traders without hefty trading banks to work with. That’s because you need lower capital to get started than traditional investments, especially if you trade CFDs on leverage.
- A chance to profit from rising and falling markets
- You can open long (buy) and short (sell) contracts on underlying assets using CFDs. This means there are ways to profit from all types of market conditions, be it bullish or bearish.
- Trade the global markets within a single platform
- You can access all available CFDs within any of the trading platforms supported by your chosen CFD broker. At ActivTrades, we support MetaTrader 4 and 5, TradingView, as well as our own proprietary solution, ActivTrader.
How to Trade CFDs Online
If you’re new to CFD trading online, here’s a step-by-step guide to placing your first CFD trade:
- Pick a reliable CFD broker that’s licensed, well-regulated and no stranger to winning industry awards.
- When opening your CFD trading account, provide the basic personal information necessary to verify your identity and address.
- Fund your account using a preferred payment method.
- Alternatively, practice CFD trading risk-free first using a demo account where possible.
- Familiarise yourself with the best trading platform provided by your broker which suits your needs best.
- Pick the asset you wish to trade and decide whether you want to go long (buy) or short (sell).
- Set your position size and direction and use risk management tools like stop-loss orders to put a ceiling on the maximum loss per trade.
- Be cautious with leverage from the outset – always use tight stop-loss orders to shield your bank from magnified losses.
CFD Trading Strategies
It’s very important that you develop trading strategies which provide direction and risk management to CFD trades. As a novice, you might be best to start with basic strategies like trend-following, spotting trends within the market to align trades with prevailing momentum. You may find trading ranges where you can frame a trade at the support price and aim to close the position for a profit at the resistance price.
Mastering technical analysis is vital to understanding market trends. The tools and indicators at your disposal offer insights into price patterns, as well as potential entry or exit points.
At ActivTrades, our proprietary ActivTrader platform includes industry leading functionality like moving average indicators, Bollinger Bands and relative strength index (RSI) indicators to add an extra dimension to your decision-making. Using these tools to build your own strategies refines your own trading skills, while minimising downside risk and maximising upside potential.
Why ActivTrades is Regarded the Best CFD Broker
What should you look for when opening a CFD account with a broker? What sets great CFD brokers apart from the rest?
- Competitive trading fees
- Swift account opening
- Responsive customer support
- User-friendly CFD trading platform options
- Tight spreads
- Educational content
You’ll be pleased to know that ActivTrades ticks all of the above boxes when it comes to a CFD broker you can trust. We’ve designed and built our own trading software, ActivTrader, that’s built with you in mind. We also sit above the average CFD brokers in terms of typical spreads, with as little as 0.5 pips offered in forex, while indices CFD spreads start from only 0.23 pips.
Having served the retail trading market for almost two decades, we’ve developed a trading education library that’s brimming with seminars and manuals to put you on the right path with your trading.
We’re a multi-award-winning CFD broker too, with our peers recognising us for our online trading services and commitment to CFD excellence in forex and many other asset classes.
CFDs Trading FAQs
What’s the difference between CFDs and spread betting?
The key difference in the CFD vs spread betting debate lies in taxation and structure. CFDs may incur capital gains tax from the buying or selling of contracts to speculate on price movements. Meanwhile spread betting is a tax-free bet on price movements.
Is CFD trading different from futures trading?
The CFD vs futures debate is settled when talking in terms of flexibility and ownership. With CFDs, you can trade the market price of underlying assets with a flexible expiration of contracts. With futures, there are standardised contracts to buy or sell assets at set prices on fixed dates.
Is it viable to use CFDs for hedging?
Yes, absolutely. CFDs are a useful hedging tool, allowing you to offset potential losses in physical assets by speculating on price movements. It’s a means of protecting your portfolio from downside risks in the market.
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