What is CFD trading?

Last Updated on March 30, 2022

CFD trading basics for beginners

CFD represents Contracts For Difference, that means it is a derivative product, where your profit depends on the difference in the price of stocks and shares. Imagine you are buying a share for GBP 10 and the price of the share raises to GBP 10.50, then you gain from the difference of price.
Which means if you had bought 2000 CFDs, then the profit you will make is GBP 1000. Now it must be clear that your profit depends totally on the difference of the share price, you profit with the rise in price.
With the risks involved, still cfd has lots of advantages:

1. Leverage is the top most factor what makes cfds so attractive to investors. Generally a leverage of 1 in 10 is offered but a leverage of upto 1 in 20 is offered by some brokers to attract investors. When you have such a big leverage, it is easy for the investors to trade with a small investment and make considerable profit. You might be trading stocks with 30 % return in profit per year which means with an investment of GBP 3000, you maintain a profit of GBP 1000. But in cfds, since you use a big leverage, you can maintain a profit of 300% with is GBP 10000.

2. Second reason why investors prefer cfd because unlike stocks and shares, you can profit even when the share price falls. As i said earlier, the cfd trading is done based on the difference in share price. So it doesn’t matter whether the market is bearish or bullish, you still make the profit.

3. Considering the costs and expenses in the cfd trading, it is very low compared to stocks and share trading because of the big leverage offered in the cfd trading. Interest and leverage are the 2 main expenses in the cfd trading.

4. One more advantage of trading cfd is setting up the option of stop loss. Stop loss is mainly to reduce your loss, because its a normal tendency of human to gamble further even if they feel the loss. So cfd gives the option of stop which automatically triggers the stopping of the cfd trading.

5. Unlike stock trading, in cfd trading there is an option of placing trade in the evenings. Which means you can set the trading amount and volume the previous day and prepare yourself for the next day. It is also very advantageous for the people who work and there are automatic systems available to trade cfds even if you are not before you personal computer.
There you go, we have analyzed the pros of cfd trading, and now to look at some expenses as i mentioned earlier.

Interest.

When you using cfd for long position, which means holding the cfds overnight, interest is charged. Conversely interest is paid to you if you hold a short position. Normally the interest charged would be the rate plus 2%, and the interest paid would be rate minus 2%. Here the rate refers to the banks prescribed overnight interest rate. For instance the interest rate of a major bank could be 5% or in other words .05 per year. Now to calculate the interest, all we have to do is divide .05 by 365 and then multiply it by the number of days involved in trade, adn then multiply by the size of the trade. So imagine, your trade size is GBP 10,000, which you had been holding for 14 days, then the interest would be GBP 15. Not a big expense in my opinion. In long stand, cfd traders would not be even bothered about these small expenditures.

Commission

There is actually no concept of commission in cfd trading which makes even more advantageous to trade cfd. But there might be some situations where some brokers charge a small commission because of their years of experience and reputation. It might be as low as 0.15%. When you are trading at a leverage of 10 in 1, these small expenses doesn’t make much of impact.

Author: Eduardo Montero

I'm Eduardo Montero. Computer scientist by profession and passionate about online trading with more than 10 years of experience in the financial markets. I'm the author of hundreds of articles published in other websites about the online trading industry. Learn more about me here: About the author.