What is CFD trading? Contracts for Difference Explained
Do you want to trade the financial markets, but don't know where to start? Then CFDs, or Contracts for Difference, might be a match for you! CFDs have low barriers to entry in terms of cost and the ability to trade anywhere online. However, they are somewhat technical and abstract, which means a lot of aspiring traders aren't sure what they are or where to start.
Never fear! In this article we'll explain what CFDs are, how they work, the benefits and risks of CFD trading, how to trade CFDs, different types of trading, choosing your trading platform and more.
What are CFDs?
CFD stands for 'Contract for Difference', and it is a contract to exchange the difference in the value of an asset from the time the contract is open, to the time the contract is closed.
So what does this actually mean? What is CFD trading?
To understand CFDs and how to trade them, the best place to start is with traditional investing. If you wanted to invest in a company, you would buy some shares at the current share price. If you wanted to invest in gold or oil, you could buy a bar of gold or a barrel of oil. Then you would wait for the price (hopefully) to increase, and you would sell the asset at a higher price, and make a profit on the difference.
CFD trading works in a similar way - you open a trade on an asset at a certain price, wait for the price to increase or decrease, and then make a profit (or a loss) on the difference. One of the biggest differences between CFD trading and traditional investing is that you never actually own the asset. Instead, a CFD reflects the price of the underlying asset, and rather than buying that asset, you can speculate on how the price of that asset might change.
How does CFD trading work? An introduction to CFDs
If we put aside jargon like 'contracts' and 'underlying assets', trading CFDs simply gives you the opportunity to profit if a market moves up or down.
To do this, you will need:
- To open a trading account with a CFD broker.
- To download that broker's CFD software, or platform.
- To choose an asset you would like to trade.
- To decide whether you think that asset's price will go up or down.
Let's say that the price of gold was $1,500 an ounce, and you thought it might increase. In that case, you could open a 'buy' trade in your trading platform - this is known as a 'long' trade, and it means that you will open the trade at one price, expecting that the price will rise, and then you will close the trade (or 'sell') at a higher price, making a profit on the difference between the sell and buy price.
So, if you opened the trade when gold was priced at $1,500, and then closed the trade when gold hit $1,525, you would make a profit of $25. (Note that this is a simple example, and we'll get into a more detailed overview of how to calculate CFD trading profits and losses later in this article.)
If you thought the price of gold was going to fall, on the other hand, you could open a 'sell' trade in your trading platform. This is known as a 'short' trade, and it means you open a trade expecting the price of an asset to fall, and then close the trade (or 'buy' the asset back) and make a profit on the difference.
So if you opened a short CFD trade when gold was priced at $1,500, and then closed the trade at $1,450, you would make a profit of $50.
CFDs follow the price of the market, so how successful (or unsuccessful) your trades are depends on the market's performance).
If you're interested in getting started, you can see the process for opening a demo trading account in the video below:
Ready? A demo CFD trading account allows you to try trading the markets with real-time market data, without risking any of your hard-earned money. Instead, you can set a virtual account balance which you can then use to build your skills. Find out more and sign up today using the banner below!
What are the benefits of trading CFDs?
While there are plenty of CFD brokers who would be eager to provide you with a long list of benefits, sometimes it can be hard to know what to believe - is everything they're saying true, or is it just a sales pitch?
Here you can keep reading for a balanced overview of the benefits of CFD trading, followed by some of the risks involved.
One of the biggest benefits of CFD trading is the use of leverage, which means you can access a larger portion of the market than what you could buy traditionally with the money you have available on your account (known as the margin).
Depending on the instrument you're trading, your local regulator and your broker, as a Professional trader you may be able to open trades of a value that's up to 500 times the value of your account balance. For Retail traders, some instruments allow trades of up to 30 times your available capital.
So if you have $1,000 on your account and available leverage of 1:30, you can access $30 for every $1 on your account, or make trades that are valued up to $30,000.
If we go back to the example of investing in gold, if you wanted to buy an ounce of gold valued at $1,500, you would need to spend $1,500. With CFD trading, on the other hand, you can open a trade of that value with a fraction of that amount on your account.
If you are trading with a CFD broker that allows leverage of 1:20, this means that for every $1 you have on your account, you can trade $20 worth of gold. So if you wanted to open a trade on the equivalent of one ounce of gold, valued at $1,500, you would need a margin of $300 on your account.
This means that, with a relatively small deposit, you can still make the same profits (and losses) you would make in traditional investing. The difference is that the return on your initial investment is much higher. The risk is that potential losses are magnified to the same extent as potential profits.
Gold CFD trade
Long gold trade opens at $1,500, closes to $1,525
You make $25, or 8.33%
You make $25, or 1.67%
Long gold trade opens at $1,500, closes to $1,450
You lose $50, or 16.67%
You lose $50, or 3.33%
You can see how different levels of CFD leverage work in the infographic below.
Trade long and short
One of the downsides of traditional investing is that you only make a profit when the markets are going up. If there is a market crash or one of your assets has a downturn, it could have a negative impact on your investments as a whole.
CFD trading, on the other hand, allows you to trade both long and short, meaning you can profit in both rising and falling markets.
In a long CFD trade, the trader thinks that the value of an asset will increase. So they open a 'buy' trade at a lower price and then sell (or close the trade) at a higher price for a profit. (If the market turns and the price decreases, the result will be a loss.)
Source: GOLD, H4 Chart - MT5 Admiral Markets. Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
In a short CFD trade, the trader thinks an asset will decrease. Therefore, the trader opens a 'sell' trade, and will close it at a lower price, making a profit on the difference. Like in a long trade, if the asset's price moves in the opposite direction to what you expected, the trade would end in a loss.
Source: EURUSD, Chart H1, MT5 Admiral Markets. Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
With the ability to trade both long and short, CFDs allow traders to find opportunities in any market.
Wide range of CFD markets
Because CFDs are derivatives of other assets, CFDs can be created to represent virtually any market. In fact, many brokers (like Admiral Markets) give traders access to thousands of financial markets through a single trading platform.
Just some of the markets available for trading as CFDs include Forex currency pairs, shares, commodities, cryptocurrencies, ETFs, stock indices, bonds and more. This includes access to markets that would otherwise be untradeable, like stock indices.
Forex CFD Trading
CFDs on Forex allow you to trade on various currency pairs. These include Forex majors, like the EUR/USD, GBP/USD, USD/JPY and AUD/USD; Forex minors like the EUR/GBP and AUD/NZD; and exotic Forex pairs like the USD/CZK.
The currency market is highly speculative and highly volatile, which creates many opportunities for savvy traders. The market is also open around the clock - 24 hours a day, 5 days a week - meaning you can schedule your trading around other commitments like work and family.
If you're interested in learning more about Forex trading, check out our ultimate beginner's guide to Forex!
Some of the most popular Forex CFDs include:
- The EUR/USD
- The GBP/USD
- The USD/JPY
- The EUR/GBP
Index CFDs are an excellent opportunity for new traders who want to trade on the movements in markets as a whole, but aren't sure about which stocks or specific instruments to pick.
Since stock indices represent a selection of stocks (e.g. the DAX index represents the 30 largest and most liquid companies on the Frankfurt Stock exchange, while the S&P500 represents 500 of the US's largest companies), they can be used to gauge the performance of a market as a whole. And while there is no traditional way to buy or sell an index, you can trade on this performance using index CFDs.
Some of the most popular share CFDs include:
- The DAX30 CFD
- The DJI30 CFD (representing the Dow Jones)
- The FTSE100 CFD
- The NQ100 CFD (representing the Nasdaq100 index)
Commodities can also be traded via CFDs, including metals like gold and silver, energies like oil and natural gas, and agricultural commodities like coffee, cotton and orange juice.
Where a traditional investment would entail a much higher upfront cost, not to mention storage, commodity CFDs allow you to trade on the price movements of these assets without owning the assets themselves.
Some of the most popular commodity CFDs are:
- Spot gold share CFDs
- Spot silver CFDs
- Brent crude oil CFDs
- WTI crude oil CFDs
Ready to get started? Take the first step towards trading gold by clicking the banner below!
Shares can also be traded via CFDs, with a number of unique benefits.
First, on long trades (or buy trade) you can collect dividends on the underlying shares for your CFD trade, potentially creating an additional stream of income. Like other CFD instruments, share CFDs also benefit from leverage, which allows you to access more shares than you would be able to through traditional investing. Finally, share CFDs can also be short sold, which gives you the opportunity to profit in a downturn.
Some of the most popular share CFDs include:
- Apple share CFDs
- Facebook share CFDs
- Google share CFDs
- Netflix share CFDs
- Tesla share CFDs
CFDs on cryptocurrencies
Since 2017, cryptocurrencies have generated a lot of interest in the financial markets, led by Bitcoin. Bitcoin is without a doubt the most famous cryptocurrency, and many online brokers offer CFDs on Bitcoin - either crossed with fiat currencies like the USD or EUR, or crossed with other crypto coins like Litcoin, Ripple and Ethereum.
Some of the most popular CFDs on cryptocurrencies include:
- The BTC/USD CFD (Bitcoin crossed with the USD)
- The BCH/USD CFD (Bitcoin cash crossed with the USD)
- The ETH/USD CFD (Ethereum crossed with the USD)
- The XRP/USD CFD (Ripple crossed with the USD)
- The LTC/USD CFD (Litecoin crossed with the USD)
If you're curious about trading cryptocurrencies, you can see the crypto CFDs we have available by clicking the banner below! From there, you can easily create an account and start trading.
CFD trading hours
As we've already covered, CFDs reflect the prices of their underlying assets. They also reflect the trading hours of those assets, which means there is always something available to trade - 24/7.
Here are some of the trading hours for popular types of CFDs:
- Forex CFDs: Available for trading 24 hours a day, 5 days a week
- Index CFDs: Available for trading 24 hours a day, 5 days a week
- Share CFDs: Available for trading during the hours of the relevant stock exchange
- Commodity CFDs: Available for trading 24 hours a day, 5 days a week
- Cryptocurrency CFDs: Available for trading 24/7
Across a week as a whole, CFD trading is available on Forex, commodities and indices from midnight on Sunday evening until 11pm on Friday, London time.
Generally, the busiest times for CFD trading (when we tend to see the most volatile price movements) are when the different financial markets overlap. With this in mind, most traders consider the most important trading windows to be:
- London: 8am - 5pm GMT
- New York: 1pm - 10pm GMT
- Singapore: 8pm - 5am GMT
- Tokyo: Midnight - 9am GMT
Generally the Asian sessions are the quietest for most instruments.
Short-term CFD trading
CFDs are also a useful tool for short-term trading, giving you the opportunity to capitalise on short-term price movements in the stock, index or commodity markets, without having to put up a large starting investment.
If you are thinking about short-term trading, or even scalping, it's important to choose a CFD broker that offers fast execution speeds for their trades. A good broker should be able to execute trades in less than a second, which is essential in fast-moving markets.
CFD expiration dates
Another benefit of CFD trading is that most CFD trades do not expire. While some markets may have expiry dates built into the trade, share CFDs do not. Instead, you can close your share CFD positions at any time you wish.
The benefit of this is that you can make very long-term trades without worrying about them being closed before you are ready due to hitting an expiration date. (Having said that, there are times when a trade may be closed on your behalf, such as if there aren't enough funds left on your account.)
Of course there are some exceptions, such as CFDs on commodity futures, which have a future expiration date. That being said, you do not have to wait until the expiry date to be released from your futures contract - as you can trade out at any given time.
Costs of trading
Finally, the cost of trading CFDs is often lower than other forms of investments. We've already discussed traditional investments, where you need to pay the full value of the asset in order to invest. With lower margin requirements, CFDs have a lower cost of entry.
In addition, CFDs have no opening or closing fees. Instead, most CFD brokers earn what is known as 'the spread'.
If you look at any CFD in your trading platform, you'll see there are two prices quoted - one to buy the CFD, and one to sell it. These are known as the bid (buy) and ask (sell) prices. You'll also notice that there's a difference between the two prices - this is known as the spread.
If you open a buy trade, or a long trade, the price of the underlying asset needs to cross the spread before the trade becomes profitable. For example, if you were trading gold and the bid price was $1,500 and the ask price was $1,501, the price of gold would need to increase to $1,501 for you to break even, and would need to increase further for you to make a profit. The $1 spread goes to the broker.
Some instruments might also have commission charges, like shares and share CFDs. In addition, if you keep a trade open overnight, you might be charged an interest fee, known as the 'swap'.
You can calculate the fees on a potential CFD trade using our free CFD calculator.
These charges are all fairly minimal - they tend to be much lower than traditional broking fees.
What are the risks of trading CFDs?
Like every investment, there are risks involved in trading CFDs as well as benefits. CFDs are complex products, which carry a great risk, so it is important to do your research before you start trading.
The first risk of CFD trading is market risk. If the market moves in the direction you traded, you will make money. If it moves against you, you will lose money. This is the same as in other forms of trading and investing.
However, because CFDs benefit from leverage, these losses can be more extreme when compared to your initial investment. As we covered earlier, CFDs are leveraged products, which gives you the ability to trade a large portion of the market for a relatively small deposit. This amplifies your potential profits, but it also amplifies your potential losses. With an investment of 5,000 euros you can gain 50,000 euros, but you can also lose the same amount.
In volatile markets, this could even lead to your balance dropping below 0, known as a negative account balance. With this in mind, it is very important to choose a broker that offers a negative balance protection policy.
Who can trade CFDs?
CFD trading is available to anyone over 18 years old. It usually appeals to traders who want to:
- Diversify their portfolio in terms of asset types
- Diversify their portfolio in terms of time frame (having both short-term trades and long-term investments)
- Try different trading strategies and styles, including intraday trading, swing trading and scalping
- Take advantage of both rising and falling markets
To invest in CFDs you don't need a degree or studies in the field of finance. However, even though you don't need formal education, it's still important to educate yourself on the markets, trading strategies, risk management and money management to give yourself the best chance of success.
With that in mind, why not register for a free Admiral Markets webinar? In our Trading Spotlight series, three pro traders join us three times a week to take a deep dive into the world's most popular CFD trading topics - volatile markets, beginner's strategies, trading psychology and more.
Simply click the banner below to register today!
How to start trading CFDs
Now that we've covered the background on what CFDs are and the risks and benefits of trading them, you're probably wondering how you can start trading. While there are a few steps involved, but we've broken it down into a simple guide so you can get started.
Step 1: Create a CFD trading account
To trade CFDs, you need to have a trading account with a CFD broker. This could be a live account, where you deposit money and use that to trade on the markets, or it could be a demo account, where you can get to know the software and practice your skills with virtual money.
To open a demo account, follow these steps:
- Go to the demo account page and complete the form.
- Your demo account details will appear on the page, and will also be emailed to you.
- To trade online, click 'Start trading'.
- To trade from your computer, jump down to Step 2 where we'll explain how you can download a CFD trading platform.
You can also see the process in this video:
If you'd like to open a live account, follow these steps:
- Create a Trader's Room account. Trader's Room is a dashboard where you can manage your live and demo accounts, deposit and withdraw funds, and download trading software.
- You will get an email with your account details - just click the link to activate your account.
- Once you're account is activated, log in here.
- Click the 'Open live account' button to start your account application.
- Enter your details, keeping in mind that you will need documents to verify your identity, like a passport.
- Once your application is reviewed, you will receive the results by email.
You can see the process in this video:
Step 2: Download a CFD trading platform
Picking the right CFD platform, or CFD software, is one of the first things to consider when trading CFDs. In fact, it will probably be one of the things you think about when choosing a CFD broker in the first place.
The most popular platforms in the trading world are MetaTrader 4 and MetaTrader 5. Designed for trading CFDs and Forex, the MetaTrader platforms have advanced charting features, trading indicators and a large support community. These platforms are also some of the most stable, user-friendly and accessible on the market.
At Admiral Markets, the available MetaTrader platforms we offer include:
- MetaTrader 4 and 5 on Windows and MAC
- MetaTrader 4 and 5 on iPhone and iPad tablets
- MetaTrader 4 and 5 for Android and tablet PCs
- MetaTrader WebTrader for browser-based trading
If you're ready to start trading CFDs, you can download MetaTrader 5 by clicking the banner below. Gain access to real-time market data, technical analysis, insight from professional trading experts, and thousands of trading instruments.
Step 3: Choose your trading methodology
Now that you have the foundations in place, the next thing to think about is your CFD trading methodology. With so many potential trades available across so many markets, it's important to have a plan of attack.
Here are some of the elements to consider in your trading approach:
- Your routine: When will you look at the markets each day? Will you be watching them constantly, or would you like trades to automatically open and/or close when you're not at your desk?
- Your style: What kind of trader are you? Day trader, scalper, swing trader or will you manage long-term trades?
- Your markets: Which markets will you focus on? Shares, Forex, commodities, indices or crypto?
- Your strategy: How will you make trading decisions to buy, to sell, or to exit a position at profit or loss?
- Your risk management: What position size, stop losses and take profits will you set in order to limit your risk?
- Your support: How often can educate yourself by reading the library of educational articles and tutorials on offer to further develop your skills?
You may not know the answer to some or any of these questions yet - don't worry, we'll be going into more detail about trading styles, manual vs. automated trading and types of analysis shortly, which will help.
In any case, it's important to remember that trading is a practical endeavour, where opening a live, or demo account and watching how markets move can help you understand much more about trading the world's financial markets.
Step 4: Make your first CFD trade!
To make your first CFD trade on a live or demo account, just follow these steps:
- Open MetaTrader and log into your trading account.
- Go to the 'Market Watch' window.
- Double click on the CFD of your choice.
- Choose the number of lots in the order window (this is the size of your position - we will discuss it in more detail under 'calculating CFD profits and losses').
- Click on 'buy' if you think the CFD will increase in value, or 'sell' if you think the CFD will decrease in value.
- Your trade will open, and it will appear in the 'Toolbox' window as an active trade.
- To close your trade, double click the active trade and click the 'Close' button.
Once you've closed your trade, it will appear in the 'History' tab of the Toolbox window.
To see the full process, in the platform itself, watch the video below:
Find your CFD trading style
When you are thinking about your trading approach, one of the things you'll need to consider is your trading style. Many CFD trading styles start with the time frame in which you want to trade, ranging from scalping, where trades are executed within minutes, to longer-term trading.
' Scalping' is a type of trading where trades are usually opened and closed within minutes. In most cases, scalpers only get only a few pips per trade (a pip is 0.0001 of a CFD's value - you can learn more about pips here). Because of this, scalpers often need to make high-volume trades and use high leverage to make a significant profit.
This can be exciting in volatile markets, but it's also very risky, as you can lose money just as quickly as you can make it. With this in mind, most beginners would be better suited to longer-term trades.
Day CFD trading
Day trading is when a trade is opened and closed within a day, so trades might last for several hours. Day traders often try to trade on changes in market directions, which can make the approach similar to scalping, since it is trading in response to the market reactions, just on a longer time frame.
Swing trading for CFDs
Swing trades usually range from being one day in length to one week in length. The objective of swing trading is to take advantage of the momentum of the market, whether bullish or bearish.
Long-term CFD trading
In CFD trading, 'long term' refers to any trade that is longer than a week. Although long term trading can be based on technical analysis, in most cases this style of CFD trading most considers fundamental analysis and what macro data has to contribute to the markets.
Manual vs. automated CFD trading
Beyond trading styles, the way trading is carried out can also vary from trader to trader. Most trades are either manual or automated.
Manual CFD trading
In manual CFD trading, a trader who manually makes the decision to buy or sell, and is physically clicking buttons (or setting pre-determined stop losses and take profits) to make trades.
For decision making, the trader can rely on different types of analysis such as fundamental, technical or wave analysis. Some experts recommend that new traders start with a manual trading strategy, simply because this is a good way to learn about the markets and how they work. However, this type of trading can be complicated since new traders don't have a clear strategy yet, which means they can struggle to maximise the profitability of their market entries and exits.
Automated CFD trading
Trading can be partly or fully automated, with programs available that can highlight trading opportunities for a trader, and others available that can even open and close trades on a trader's behalf.
These programs use algorithms based on a trader's requirement that indicate the best time to enter or exit a trade. The main benefit of this type of trading is that it takes the emotion out of trading and forces you to follow your strategy.
If you are considering automated CFD trading, we recommends performing numerous tests with any new program or robot so you feel comfortable with its performance. Fortunately, MetaTrader allows traders to backtest trading strategies on historical data, which gives you the opportunity to see how a CFD trading program might have performed in different scenarios.
In fact, one of the best tools for automated trading is MetaTrader Supreme Edition - a free MetaTrader plugin available exclusively to Admiral Markets traders. With MetaTrader Supreme Edition, CFD traders can boost their trading capabilities by accessing the latest real-time market data, insights from professional trading experts, and a range of additional features such as a range of expert advisors, which allow for automated trading. To download MetaTrader Supreme Edition for free, click the banner below!
CFD analysis: How to analyse CFD markets
Technical analysis believes that history will repeat itself, and therefore analyses historical price patterns to predict how a CFD's price might change in the future.
Fundamental analysis, on the other hand, focuses on news and macroeconomic events that may influence a CFD's performance.
Calculating CFD profits and losses
Once you are ready to start trading, if you're actively managing your risk and money you will probably want to figure out how to calculate potential profits and losses before you trade.
The good news is that we have a handy calculator that can do this for you! Check out our CFD trading calculator, where you can estimate the profit and loss of trades by adjusting the instrument, available leverage, account currency, open price and close price.
If you want to understand some of how the calculator works, keep reading.
Step 1: CFD price difference
The first step for calculating the gains and losses in a CFD account is quite simple. It is the difference between the value of an asset at the time of opening a trade and the value of the asset at the time the trade is closed.
In long trades, you can calculate this by subtracting the opening price of a trade from the closing price of a trade. In short trades, you can calculate this by subtracting the closing price of a trade from the opening price.
So if you opened a long trade on the EUR/USD at 1.1073 and closed it at 1.1152, the difference is 0.0079 (or 79 pips, with one pip being 0.0001).
Step 2: CFD trade volume
Now that you know the difference in price, you need to multiply it by the size of the trade. That is the volume of the trade (known as the number of lots or contracts) by the value of each price movement.
Lots, or contract size, are the standard amount that each contract is worth. While this varies from CFD to CFD, it can be learned.
In Forex pairs, for instance, one lot is 100,000 units of the base currency, or the first currency listed in a Forex pair. So one lot of the EUR/USD is worth €100,000, while one lot of the AUD/USD is worth AUD100,000. If these numbers are feeling a bit large, the good news is that many brokers like Admiral Markets also offer mini lots (0.1 lots) and micro lots (0.01 lots), which allow you to open smaller trades.
Source: Admiral Markets trading calculator
For metals like gold and silver, one standard contract is 100 ounces, while the contract size for indices like the FTSE100 and DAX30 is one CFD. If you would like to find out the lot or contract size for a particular instrument, you can do this using our trading calculator.
To calculate your total trade volume, you simply multiply the number of contracts by the total size of the contract. So three 0.1 lots of the EUR/USD would be valued at $30,000.
0.1 x 3 x €100,000 = €30,000
Step 3: Point movement value
The next step is to calculate the value of each point movement. Again, this can get confusing because it varies from asset to asset, which is why it's helpful to use our trading calculator to look up the specific instruments you're interested in trading.
For currency pairs, the formula to figure out the value of a pip is to multiply one pip by the contract size - this gives you the value of one pip in the quote currency (the second currency in the pair). So for one lot of the EUR/USD, the formula would be:
0.0001 x 100,000 = $10
Every one pip movement (so every movement of 0.0001) is valued at $10. For a mini lot (0.1 lots), that would drop to $1, and for a micro lot, that would drop to $0.1.
If we put all three points together (CFD price difference, CFD trade volume and point movement value), we can use that to start calculating your trading profit or loss.
As a refresher:
- Price difference = closing price - opening price (for long trades)
- Trade volume = contract size x number of contracts x contract value
- Point movement value = point size x contract size
To calculate your trade's profit or loss, you need to multiply the price difference by the trade volume by the point movement value.
(closing price - opening price) x (contract size x number of contracts x contract value) x (point size x contract size)
To go back to our example earlier, let's say you opened a long trade on three mini lots of the EUR/USD at 1.1073 and closed it at 1.1152. This gives us:
(1.1152 - 1.1073) x (0.01 x 3 x €100,000) x (0.0001 x 10,000)
0.0079 x €30,000 x $1 = $237
The same formula works for calculating trading losses - the price difference will be negative, and this will lead to a negative result, or a loss.
Here are some more examples:
Profitable CFD trade:
- You buy two contracts of the DAX30 CFD at 12,000 points. The price goes up to 13,000 points and you close your position.
- Your profit = (13,000 - 12,000) x (1 CFD x 2 x €1) x (€1) = +€2,000
Losing CFD trade:
- You buy two contracts of the DAX30 CFD at 12,000 points. The price goes down to 11,000 points and you close your position.
- Your profit = (11,000 - 12,000) x (1 CFD x 2 x €1) x (€1) = -€2,000
Beyond the movements of the markets themselves, you will also need to consider the costs of trading CFDs when calculating your net profit.
Step 4: CFD trading costs
There are three potential costs involved in trading CFDs - CFD spreads, commissions and swap fees.
The spread is the difference between the bid and ask price of a CFD. The bid price is the price you pay when you're buying a CFD, while the ask price is the price you pay when you're selling a CFD. So if you open a long trade, you would open the trade at the bid price, and close it at the ask price (and vice versa for short trades).
Source: Admiral Markets MetaTrader 5 trading platform
Generally there is a difference between the bid and ask price - this is known as the spread and it is paid to your CFD broker as a fee. For a trade to become profitable, it first needs to cross the spread - so in a long trade, the price not only needs to rise above the original bid price, it also needs to climb beyond the original ask price.
If we return to our EUR/USD trade, if the Forex paid has a one pip spread (so that means a difference of 0.0001 between the bid and ask prices), the pair needs to move by at least one pip before it becomes profitable. So in the price difference we calculated before - 79 pips - you would need to subtract one pip to calculate your profit minus the spread.
This is why so many brokers promote their low spread - because spreads eat into your trading profits, one of the things to look for when choosing a broker is how low their spreads are.
Here are some examples of typical spreads on some of the most popular CFDs at Admiral Markets:
CFDs on Forex
CFDs on Commodities
CFDs on Cryptocurrencies
The next cost of trading is commissions. Depending on your broker, a commission might charged in addition to the spread or instead of the spread. They also tend to be charged for certain underlying instruments, like share CFDs.
At Admiral Markets, we charge commissions from just $0.01 per share on our CFD accounts in MetaTrader 4 and MetaTrader 5. In addition, we offer advanced traders the Zero.MT4 account, which charges commissions on commodity, index and Forex CFDs, but offers spreads from 0 pips.
The third CFD charge is the swap, which is an interest adjustment charged for holding positions overnight. In long trades, this is charged as a fee and is deducted from a trade's profit, while in short trades it may be paid as a rebate, and added to a trade's profit.
Tips for trading CFDs
While the concept of trading CFDs is quite simple - the profit or loss is the difference between the purchase price and the sale price of an asset - this doesn't mean that it is easy to perform a good trade.
This is why it's important to educate yourself before you start to trade the live markets. There are a range of free resources you can use to do this - free articles, online trading courses and even live webinars taught by trading experts.
In fact, Admiral Markets is currently running a free webinar series that features three pro traders, three times a week, talking about the most sought-after trading topics - trading strategies, different markets, how to get the most out of your CFD software, and more.
To find out more and register today, click the banner below!
While you wait for your next webinar, here are seven beginner's tips to help you start trading CFDs.
1. Let winning trades run and cut your losses
Many new CFD traders (and even some more experienced traders) limit their chances of profit by not following this rule. Simply, a winning trade should be allowed to run until it achieves maximum profitability, while losing trades should be cut as soon as possible.
This can be difficult for new traders to assess, which is why it's a good idea to start trading with a demo account, which will help you understand how the markets work and what winning and losing CFD trades look like.
2. Trade with logic, not emotion
A trader who bases decisions on emotions, intuition and gut feelings may occasionally win, but this approach isn't profitable in the long term. Instead, profitable CFD traders have have strict trading rules and follow them at all costs. Part of learning to trade successfully is simply learning to follow your rules.
3. Don't put all your eggs in one basket
A trader who risks 50% or 100% of his capital in a single trade is not a trader - what they are doing is the equivalent of gambling. One of the most common risk management guidelines is not to risk more than 2% of your account balance on a single trade - this ensures that a single losing trade doesn't clear your account balance or trigger a margin call.
Beyond risking all your capital on a single trade, it's also important to ensure that all of your trades aren't on the same instrument or market. Investing in different instruments and sectors will help ensure your portfolio is diversified.
4. Combine fundamental and technical analysis
When performing analysis on CFDs, a trader who uses both fundamental and technical analysis is more likely to be successful than someone who uses only one of these analyses in their trading. One way to combine these approaches is to use fundamental analysis to trigger trades, and technical analysis to monitor and decide when to close the trades.
5. Trade at the right time
Even if you have correctly identified a trend, opening a trade too soon or too late can lead to significant losses. It is better to wait until you receive a trading "signal" - such as an asset's price breaking through support or resistance, or a moving average crossover. Ideally, the potential trade should be confirmed by more than one signal.
6. Don't try to save losing trades
It's common for new CFD traders to invest even more in a losing position with the hope that the market will turn around and they will recoup their losses. This is not a good practice. If a trade is not behaving in line with your expectations, close it.
It is better to accept some losses early than to keep a trade open and potentially lose your entire account.
7. Use stop losses wisely
A stop loss is a tool you can use to limit your trading losses. Simply, you set a price at which your trade should automatically close if the markets turn against you.
A trade without a stop loss can have catastrophic consequences. However, if you place it too close to the current price, it might also close out a winning trade before it has time to reach a profit. This is why it's important to use stop losses wisely - in a way that balances safety with opportunity.
Choosing a CFD Broker and CFD trading platform
If you are wondering where to find the best CFD broker and trading platform to choose, you might start by asking around in trading forums. Unfortunately, these are not the best place to look. In these forums, there is often an affiliate agreement between the forum and the broker, which means the reviews may not be genuine.
Instead, here are a list of items to keep in mind when choosing a CFD broker:
To choose a broker you must take into account:
- Are they regulated?
- Do they offer an intuitive and fast trading platform?
- Are their trading costs competitive?
- Do they offer training and education, ideally for free?
- Do they have good customer service?
- Do they offer the markets you'd like to trade?
Admittedly, our opinion is subjective, but we believe that Admiral Markets is one of the best CFD brokers you can find. Here are just some of the benefits of trading with us:
- High security: Admiral Markets is regulated around the world by the FCA, ASIC, EFSA and CySEC.
- World-class trading platforms: We offer trading on MetaTrader 4 and MetaTrader 5, the world's most popular trading platforms, and we offer downloads to PC and Mac, both Android and iOS apps, as well as browser-based trading via MetaTrader WebTrader.
- Low trading costs: Our typical spreads are some of the lowest available - just 0.6 pips on the EUR/USD, and 0.8 points on the DAX30 CFD! Plus our commissions start from $0.01 on US share CFDs and ETFs.
- Free education: Enjoy a library of educational materials and market analysis from our Trader's Blog so you can stay up to date with all the latest market developments.
- Award-winning customer service: While we're a global company, we offer local support, with teams in 30+ countries who speak your language, and who are available via email, live chat and phone.
- Wide range of markets: Admiral Markets offers CFDs on thousands of global markets, including Forex, shares, commodities, indices, ETFs, cryptocurrencies and more!
- Negative balance protection policy: We can help keep your account balance from sliding to a negative balance with an unlimited negative balance protection policy for Retail clients, and negative balance protection of up to £50,000 for Professional clients.
- Free SMS trading notifications: Stay up to date with all the information you need regarding deposits, withdrawals or possible margin calls by registering for the free SMS service found in Trader's Room.
- Trade with leverage: Retail clients can trade positions valued at up to 30 times their account balance, while Professional clients can trade positions up to 500 times their account balance.
- Trade in any direction: Trade CFDs long or short to profit in both rising and falling markets.
Although we think we're pretty good, though, the best way to find a good CFD broker is to test them. The good news is that you can do this with a free demo account, which allows you to test their offering and trading platform, risk free!
You can open your demo account in less than two minutes by clicking the banner below.
Conclusion: CFD trading explained
As you can see, trading CFDs (or Contracts for Difference) offer the opportunity to trade a wide range of markets for a relatively low deposit. With the use of leverage you can amplify your profits, and with the ability to go short or long you can profit in both rising and falling markets.
Having said that, like any form of investing, there is the potential to lose money as well as to make it.
This is why it's important to educate yourself. Ensure you have a good knowledge of the markets, a reliable trading strategy and a fast trading platform to maximise your chances of profitability.
If you would like to learn more about trading with CFDs, check out these articles:
- What is the Best CFD Trading Platform?
- How to Choose the Best Forex & CFD Broker
- Forex Trading for Beginners: The Ultimate Guide
Trade CFDs with Admiral Markets
If you're feeling inspired to start trading, or this article has provided some extra insight to your existing trading knowledge, you may be pleased to know that Admiral Markets provides the ability to trade with Forex and CFDs on up to 80+ currencies, with the latest market updates and technical analysis provided for free! Click the banner below to open your live account today!
About Admiral Markets
Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the