What is a CFD?

What is a CFD?

what is a cfd

The  CFD  or  Contracts for Difference  are financial instruments whose value replicate the performance of a financial asset.  With CFD trading you can trade up and down on different types of assets: stocks, currency pairs, cryptocurrencies, commodities, stock indices, and more.

With CFDs, a great opportunity has opened up   for all those who, even if they are not professionals in the sector or  do not have a large capital  , can exploit their knowledge and skills to obtain benefits by focusing on  rises or falls  based on their market forecasts.

To do this, simply  log into a trading platform  , such as eToro, one of the most famous and widely used CFD platforms in the world. To open a demo account without depositing,  visit this official page  and continue with the simple instructions.

In this first lesson of the course we will highlight the main advantages of CFDs, the differences with stocks, the financial products they allow you to trade and the best platforms to trade CFDs with free demos.

CFD: meaning

CFD is an acronym for Contracts for Difference, which in Italian translates as Contratti per Difference. In fact, they are  standardized contracts  and that is why they are very practical, so much so that they can be negotiated with a single click of the mouse.

You do not need to fill out forms and sign authorizations to trade CFDs like buying stocks. Plus, it’s just as easy to close investment transactions, with an instant close, whenever you want.

Therefore, CFDs are very practical and fast investment tools. ¿  But  how do they work?

Each CFD replicates the performance of a financial asset  , such as a stock. Those who trade a CFD on an Amazon share, for example, can open a bullish or bearish position depending on their market forecast.

Once you buy a CFD (for example, an Amazon Stock CFD), this is what happens:

  • If Amazon shares rise, those who traded the most win;
  • If Amazon shares fall, those who traded lower gains.

In fact, when trading CFDs, you can open long (bullish) positions as well as short (bearish) positions.

  • When a bull position is opened   , the trader buys Long contracts   , which precisely allow him to obtain capital gains proportional to the increases.
  • When a bearish position is opened   , the trader buys short contracts   , which allow him to obtain capital gains proportional to the falls.

Trading Platforms

To trade CFDs, you need to access a trading platform. The platforms are provided by online CFD brokers and therefore you need to register first, that is, open a trading account with a broker.

In this regard, we strongly recommend that you choose regulated and authorized brokers in Italy, as only in this way can you be sure of operating safely.

A trading platform allows you to place orders with the broker, which can be of several types: opening and closing of buy or sell positions, stop loss, take profit, trade stop, pre-order and pending orders (sell limit, limit of buy, buy stop, sell stop).

CFD trading: the best platforms

Here we provide a list of the best platforms for online CFD trading, regulated in Europe by Cysec and provided by companies registered in the Consob registry. Therefore, they are licensed, safe and legal brokers, as well as very famous.

Advantages of CFD Trading

Trading CFDs has many advantages, which we could summarize in  economy  (compared to traditional investment),  practicality  ,  convenience  ,  speed  .

With CFDs, you have the opportunity to trade online from your computer, smartphone or tablet, with  virtually no bureaucracy  . So with CFDs you are not buried by the bureaucratic practices that a traditional investment requires.

For example, paper securities should not be held, deposited with a bank, and traded only by inquiry and request. CFDs can be traded with one click  and open positions can be closed even after a few minutes. So you can also take advantage of raises that last for a few minutes and then close the position and make a profit.

Another great advantage is that with CFD trading you can also benefit from falling prices. To do this, you do not need to buy and then resell, but simply go  short  or ‘sell’.

Other advantages are more noticeable by making a   direct  comparison between CFDs and stocks  , which we detail below.

How CFD Trading Works

So far we have seen how you can trade, what are its advantages and what are the best platforms to trade,  but how does trading this instrument technically work?

CFD trading takes place between individual investors and the companies that offer this service, i.e. brokerage firms.

Since there are no standard contracts for CFDs, each company can determine its own, respecting some common points such as:

  • The contract for difference begins when the user (the investor) opens an up or down position on a given instrument and ends when the position on it closes.
  • The investor’s profit or loss will be proportional to the price change between the opening and closing of the position.
  • As compensation for their service, the broker generally applies a spread or spread between the buy and sell price at the opening. You can also add fees for additional services, overnight (overnight financial service fee) and in some rare cases even a management fee in case you offer portfolio management.
  • Once the market closes daily, a position is rolled over and carried over to the next day.
  • CFDs are ‘margin’ products and this means that the investing trader or user must always maintain the minimum margin level. In the event that the sum of money deposited on the CFD platform falls to a level below the minimum margin, the broker will make a margin call in which the trader will be asked to quickly cover these margins, which would otherwise will lead to the closing of positions by the broker, in order to protect himself.

How much to invest with CFDs: the margin

One very important aspect to understand regarding CFDs is  margin  . We have already mentioned financial leverage and ‘margin’. We have provided an example below so that you can understand how it works in the best possible way.

First, we distinguish the  two types of margin present in CFD trading  :

  • Initial margin  : this is the amount that the user will actually invest to trade, and is given by the following initial margin. It is calculated by calculating the relationship between the nominal capital and the financial leverage (for example, if the nominal capital is $ 3,000 and the leverage is 1:30, the initial margin will be equal to $ 100)
  • Retention Margin  : This is the margin that is required to keep the position open and that is returned when the position is closed.

Let’s take an example. We open a position at € 1,000 on the EUR / USD pair, with a leverage of 1:30. The initial margin will be equal to (€ 1,000 / 30) or € 33.33. Of these, if the maintenance margin is 50%, € 16.76 will be frozen.

They will be returned when the operation is closed. The maintenance margin is important since equity (a kind of equity that we will discuss in the course) must always remain far enough away from it, so as not to run into the margin call, or a warning that warns the user that losses have reached levels. alert.

Regarding the margins, it must be said that:

  1. Once the position is opened, changes in the share price will affect the available capital
  2. When you decide to close the position, you will receive back the margin amounts, net of profit and loss.

Costs, how much does it cost to trade CFDs?

The issue of costs can be included among the advantages since, as we have seen in detail,  trading CFDs requires much lower amounts than traditional investment.

Also in regards to the spread, or what corresponds to the broker for its service, these are very low percentages and much lower than the commissions requested by most banks.

In fact, online CFD brokers instead of earning commissions, they  benefit from opening positions by applying the spread  , so the more positions they open, the more the broker will earn.

Therefore, with CFD trading there is no conflict of interest, as the broker does not profit from the loss of the trader  , but from the amount of his trades, each of which allows the broker to retain a small percentage that it will depend on the type of instrument traded.

Normally, Forex offers the lowest spreads, which can be as low as 2 pips, as is the case with  etoro platforms.

Differences between stocks and CFDs

Property of securities

Unlike what happens with stocks,  there is no ownership of the securities to trade CFDs  , so there are not even the many red tape and costs that characterize a traditional capital investment, such as stamp duty or related costs. with management.

Although CFDs  are not securities that you are physically in possession of  , it is possible to trade them in a practical and fast way exclusively for short-term profit.

CFD expiration

However,  most CFDs do not expire  , so you can keep your position open for as long as you like, however incurring overnight costs that must be reimbursed to the broker in exchange for holding the position overnight (in short week 3 nights must be calculated).

Results in a short time

In fact, it is important to note that  CFDs are tools designed to obtain results in a short time  , buying in a bullish or bearish market, in order to benefit from the bullish or bearish variations of a stock. Unlike stocks,  CFD positions can be closed even after a few minutes  , with a simple click of the mouse.

Financial appeceament

Another big difference between CFDs and stocks lies in the  leverage  . CFDs are leveraged instruments  , therefore, for each individual trade, the user will not be exposed for the full amount of the value of the shares traded, but only for a smaller percentage.

Finally, it should be noted that CFDs allow you to have access to a wide range of stocks, which is not possible through a normal bank. It is possible to create a portfolio of equity CFDs by choosing components from thousands of stocks worldwide, which are listed on the major stock markets. So not just Italian stocks, but also numerous European, Asian and American stocks.

For example, 1:20 leverage allows you to trade shares worth 1,000 euros for just 50 euros  .

Margin rates and leverage may vary depending on the broker and the type of financial instrument used.

We will talk about this later in the lesson on CFD leverage.

In which markets can you trade CFDs?

In addition to stocks,  CFDs allow you to trade up and down  multiple financial instruments such as currencies, commodities, ETFs, and indices of various types.

Forex CFD trading

Forex CFDs allow you to trade the currency market  and then open up or down positions in currency pairs such as the euro dollar, USD / JPY, EUR / GBP and many others.

Advantages of CFD Forex trading  include the high leverage offered by brokers (around 1:30) and spreads, which are more advantageous than other financial instruments.

A tip: the lower the spread, or the difference between the buy and sell price of the CFD, the more convenient it is to open a position in a financial instrument.

Speaking of Forex CFD trading, it should also be noted that the famous professional MetaTrader 4 trading platform is optimal for this type of financial instrument, even if it is more difficult to use than others (eg  Trade.com  ).

Also read: What is the Spread?

CRYPTOCURRENCY

Cryptocurrencies are a new entry in the financial market. They have had a boom in recent years and especially with Bitcoin.

With CFDs, you will have understood well by now that you can trade both up and down, so you can trade both in anticipation of BTC rises and in view of the BTC falling forecast.

As the price swings of cryptocurrencies are very large, this offers large profit margins. However, there is a flaw: the spread of cryptocurrencies is usually very high and the leverage is very low. In practice, much higher capital is required than other financial instruments and, above all, compared to Forex trading.

Raw material

The  Commodity CFDs  allow instead to trade oil, gold, silver, copper, natural gas and other types, such as food (soybeans, coffee, sugar, cotton, etc.).

Even for commodities, the financial levers offered by brokers are often very high.

Since the prices of some commodities are very volatile, before trading with real funds we recommend a preventive study of the commodity you want to trade.

ETF

CFDs on  ETFs  have  exchange-traded funds  as the underlying.

These are  special funds whose shares are traded like shares  and are characterized by high liquidity and low management costs.

CFDs allow you to trade them up and down easily and with a good variety of funds.

Stock indices

CFDs on  indices  usually refer to the  main stock indices of the stock exchanges  , such as the Dow Jones, the FTSE MIB in Piazza Affari or the Frankfurt Stock Exchange, but also to indices of the Mid Cap type, that is, that contain mid-cap stocks.

Brokers also allow you to trade with other types of indices, such as the VIX index or the volatility index, among others.

Choices

The  options CFD  are a novelty that allows you to open positions in put and call options on indices related and others.

They are a relatively new financial instrument and are recommended for those starting their own commercial business.

As all instruments have advantages and disadvantages, we have created a course on binary options for those interested in learning more about the subject.

Trading via browser, application and software

To trade CFDs, you need software that allows you to access the market and order up and down. These software are commonly referred to as  CFD trading platforms  and are generally offered by the brokers you sign up for for free.

It should be noted that  CFD trading is feasible both with downloadable software, with dedicated applications, and with access through the browser. The compatible systems depend on the software offered by the broker, so below we will specify which operating systems are compatible with the different platforms mentioned.

Those who are not very experienced and prefer an easy-to-use platform will  find  very intuitive software  , the features of which are easily applicable by all users, to be very satisfying.

Those who have already gained experience with technical analysis applied to trading will find the use of more professional platforms very satisfactory   , among which the most famous and used is  MetaTrader 4, of which we have published an introductory course  that explains all the functionalities. offered by this software, as well as how to try it for free in demo mode.

Go to the next lesson:  CFD details

CFD FAQs

What are CFDs?

CFDs are financial instruments that track the performance of an underlying asset. 

How do CFDs work?

By tracking the performance of an underlying asset, with CFDs you can trade up and down on different financial markets (stocks, Forex, commodities, stock indices, cryptocurrencies, ETFs, bonds, and more). 

How are CFDs traded online?

Through CFD trading platforms, provided free of charge by specialized brokers. 

What are the best platforms to trade CFDs?

The platforms regulated in Europe and authorized by FCA, as they offer the highest possible security. Examples of trading platforms can be found in this article.

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