What are CFDs in trading - Key takeaways
CFDs or Contracts for Differences are instruments that help with trading other instruments. Nobody has to own any stocks, indices or commodities if they are trading them through CFDs.
CFDs can sometimes bring a very positive boost to your account thanks to the margin trading opportunity. However, if the payouts are twice as big with leverage, the losses are 5 times as big. So it’s always important to be careful with the CFD trading risks and issues.
CFDs are designed for “fast traders”, basically people who like to close trades as fast as they open them. It’s very hard to hold a long-term position with CFDs because they are restricted by deadlines. Increasing these deadlines requires fees, which can get pretty expensive.
FAQ on CFD trading
What is CFD trading and how does it work?
A direct CFDs meaning is Contracts for Difference, and this type of trading asset has become pretty popular in financial markets, whether it's Forex, stocks, or commodities. Here is how CFD works in these markets:
If you are a Forex CFD trader, it is not the actual currencies like the USD, EUR, or JPY that you are buying, rather the contracts that have those currencies as underlying assets. And the fundamental trading principle remains the same: Forex CFD trading means that you are buying/selling a certain contract at a given price, then wait for the price to increase/decrease, and once it reaches a preferred level for you, sell/buy it.
When it comes to what is CFD trading in commodities, its benefits are quite a bit more apparent. Let's take a look at the gold CFD meaning: instead of physically buying and then selling this asset, which is associated with a lot of logistical issues, with CFDs, you're just trading a contract that doesn't take any physical space.
Another great benefit of how does CFD work is the fact that you don't need to own an asset firsthand to then sell it; a contract allows you to open a short position for an underlying commodity just as easily as opening a long position.
What can be traded through CFDs?
As long as it is called a financial instrument, it can be traded through CFDs. This includes things such as stocks, commodities, indices, cryptocurrencies, currencies, bonds, and pretty much anything else.
This is considered to be the biggest advantage of CFDs. If it turns out that the currency market is not doing too well, CFD traders can quickly switch to stocks, and then to commodities if necessary. It’s a good way to diversify the portfolio.
How does leverage work for CFDs?
Leverage is probably the most important part of CFDs. It can be said that the whole idea of how CFDs work lies within leverage itself.
When opening a trade, a person can include leverage, which means that your trade is going to grow in size. This could mean bigger payouts or much bigger losses. It’s usually not recommended for beginners to use unless they’re absolutely sure they know what they are doing.
Most CFD instruments have fixed leverage ratings. For example:
- FX - up to 1:1000
- Stocks - around 1:50
- Commodities - around 1:50
- Cryptocurrencies - around 1:2
Can I lower the leverage?
Yes. Most brokers mention the maximum leverage they have available, which means that you can lower it whenever you want, or disable it completely to lower your risk when trading CFDs. If you are a beginner, most people would suggest disabling it in the beginning before you learn how it works and why it is even included in your software.
Are CFDs better than regular assets?
Yes and no. CFDs have quite a lot of advantages over regular assets, but they also have disadvantages. For example, you can trade stocks on margin which can bring quite a lot of payouts, but you can’t hold a single position for too long because there are deadlines. Postponing those deadlines can get very expensive.
Is CFD trading safe?
No. Much like any other trading method, CFD trading is very risky and requires just as much research as FX trading or stock trading would. Although CFDs can potentially bring a lot in payouts, they can potentially bring much more in losses as well. And considering how the financial market works, a loss is much more likely.
Where can I trade CFDs?
CFDs are usually traded with CFD brokers, but there are a lot of cases where Forex brokers have started offering CFD trades as well. In most cases, the brokers have a whole collection of instruments to trade through CFDs, but there are exceptions where a broker may target only one instrument.
How long can I trade CFDs?
About a week or a couple of days. Every trade is based on a futures contract, which has a CFD deadline. If you do not close your trade before the deadline, the system will do it for you. Sure you can pay a fee to extend the deadline, but as already mentioned in the guide, that could prove to be very expensive if done often. A common strategy for CFD traders is to predict very small changes in the market and open leveraged positions that they can close very fast.
What are CFD benefits that I should choose them for?
What is a CFD? It's a contract that enables you to trade just about any spot instrument with more convenience. Among many benefits of CFDs explained, the most useful one is definitely the ability to exchange an asset that doesn't have any physical dimensions.
For example, there are much less logistical difficulties when trading oil CFDs meaning you don't need to buy spot oil in its physical form. Besides, CFDs also enable to you open both buy (long) and sell (short) positions in the market, whereas with physical assets, you first need to buy them and then sell in the market.
So, what is CFD benefit? Convenience, yet it's not the only one: you can also use much higher leverage rates with CFDs. For Forex pairs, leverage can go as high as 1:1000 or even more, whereas spot assets are more limited in this sense.