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An introduction to trading CFDs

by , 29 October 2015

If you're looking for an easy to understand trading instrument, contracts for difference (CFDs) could be for you.

They're very transparent due to the way their pricing and contract sizes work. And you may be able to trade them with your current stock broker.

So what exactly are CFDs? And how do they work?

Let's take a closer look…

What are CFDs?

A CFD is an agreement you enter with another party, usually your stock broker or trading company. This agreement is to exchange the difference between the closing price of the contract and the opening price of the contract.

What makes CFDs easy to understand is that one CFD is equal to one underlying share. This is different to single stock futures, where the contract size is 100 underlying shares.

Also CFDs use the spot price, so you can easily check how prices are doing. This is because CFDs don’t use the future price like spread and single stock futures.

How CFD trades work

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To trade CFDs you can do it through a stock broker or trading company. You’ll usually have to pay commission for entering and exiting your trades, and there is also a daily funding charge to consider.

The daily funding charge occurs for each night you hold a CFD position open. If you’re in a long CFD trade, you pay this funding charge, if you’re in a short CFD trade, you receive this funding charge.

As with other trading instruments, you trade CFDs on margin. This means that you only put down a small percentage of your overall exposure. Margin requirements are usually between 8% and 25% of your overall exposure.

By trading on margin, it magnifies moves in the underlying shares. When a trade works out in your favour, this boosts your profits. But trading on margin also magnifies your losses. This is why risk management is such a crucial aspect of trading.

So there you have it. An introduction to trading CFDs.

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