Welcome to our ultimate guide on how to trade CFDs for beginners. Once you finish reading it, you will understand what CFD trading is, how it is conducted, why you should try it, and tips and tricks to minimize your risks and get a good experience with CFD trading.
CFD trading continues to take over the world by storm because of the unique features that differentiate it from other trading methods. We will get into more details shortly, but first, let’s understand what a CFD is.
CFD (contract for difference) is a derivative product that has become popular among traders globally. CFDs are cost-effective and tax-efficient, allowing you to enter the financial markets with a low budget. With CFDs, you are going to speculate on the prices of financial assets without taking ownership.
CFDs are easily accessible and you do not need an exchange to trade them. However, they are also traded on margin, so you should be prepared for the potential risks when you trade.
What is CFD Trading
As mentioned, CFD trading is a derivative form of trading that involves speculation on the prices of various financial assets. Simply put, instead of purchasing physical assets and owning them, you will only forecast the direction in which an asset’s price will head.
Trading CFD is actually buying or selling a contract, meaning that you are not obligated to buy or sell an asset. With this trading method, you get to benefit from the difference in an asset’s price* for when a CFD position was opened to when it was closed.
In case a CFD position doesn’t work in your favor, you will have to pay the difference in asset prices to your broker. That is why you should conduct thorough research and analysis on tradable assets to help minimize risks when trading.
*Remember, your money is always at the risk when trading CFD
Benefits of CFD Trading
You probably must be wondering why most traders prefer CFD trading. Well, while buying physical assets and owning them can be profitable, speculating on their price movements has more features.
One of the main benefits of CFD trading is that you can speculate on assets you couldn’t afford otherwise.
For example, most people can’t invest in Amazon since the cost of 1 stock is $3,000+. Therefore, using CFDs and investing whatever they can afford, gives them a chance to benefit from Amazon stocks anyways.
Take a look below at other benefits of CFD trading.
- Go Long and Short
Because CFD trading is a contract and you do not own the underlying asset, you can trade by upward movements (go long) or downward trends (go short).
Going long on a position means that you are buying CFDs. Here you get to speculate that the price of a trading asset will rise and trade by the difference in pricing when a position is closed.
In contrast, you can also go short on a CFD position. Based on your analysis, you can speculate on an asset’s falling price.
- Trade on Margin
Trading on margin means that you do not have to pay the total value of a CFD position. Instead, you will only make a percentage deposit based on the value of the position. After all, you are trading on price speculations and not purchasing and owning the underlying asset.
By trading on margin, a broker will loan you trading funds, giving you more flexibility to broaden your portfolio. Trading with borrowed funds is commonly known as leverage trading, and it can bring about more profits with the right strategy and market research.
Note that leverage trading is like a double-edged sword, and you should try to avoid getting cut by the wrong side of the blade. This means that should a trade work against you, the loss you incur may affect your overall trading activities.
For the above reason, it is essential to stay abreast with the news on assets and their price behaviors.
- Wide Array of Markets
Since CFD trading is about speculating the prices of underlying assets, you have no obligation to purchase an asset. Instead, you can trade on various assets freely and make profits from different markets and different price movements. CFD trading also lets you diversify your trading portfolio, allowing you to manage the risk of trading.
There are various market assets that you can trade on CFDs. These include forex, stocks, commodities, cryptocurrencies, indices, and more. These assets can be traded as CFDs on a broker’s platform. Therefore, ensure you find a CFD broker with the right offerings fit for your trading style.
- You Can Hedge Your Position
When you hedge a CFD position, it means that you will be speculating on the prices of already existing assets that are at higher risk for loss. For example, if you believe that your already existing share value will reduce. In that case, you can decide to open a CFD position by speculating its falling prices. By going short on your current position, you will speculate that the current asset’s prices will fall.
Note that you must be confident with your strategy before hedging a position. By having a trade work in your favour, you will earn profits and offset the losses on the existing trading portfolio. However, should the asset’s price start rising against your CFD position, you lose your investment funds.
- Low Trading Costs
When trading CFDs, expect to incur less to zero commission. Unless you are hedging a CFD position, most likely, the broker will charge you spreads. Spreads are the price differences between an asset’s price when a position was opened and closed.
CFD trading is also cost-effective if you open short positions that do not last more than a day. This means that you will not pay financing charges, which are fees for positions left overnight. There is also no need to find insurance and storage facilities for physical assets.
However, CFD trading is never completely free, and you can expect to pay spread on each position that you open and close.
How Does CFD Trading Work
CFD trading is a little different from trading other assets, meaning that instead of taking ownership of the whole asset, you only buy or sell a contract based on an underlying instrument. These contracts only mimic the prices of underlying assets that you will be required to speculate on. In case you are right with your speculation and have opened a position, you will earn profit.
Do not see CFD trading as a sure-fire way to make profits because there is more than just price speculation. Since CFD trading gives you access to trading with leverage, you can either win big or lose big.
You need to be analysing the financial markets more frequently so that you can identify where there is an opportunity to make profits. Additionally, get updated with the latest news and learn how to utilise charting tools provided by a CFD broker to create the best strategy.
That being said, if you are a newbie and want to try CFD trading, get started using a broker’s demo account. These demo accounts are fully loaded with virtual funds to help you practice until you are ready to try the real markets.
How to Trade CFDs
Like trading physical assets, you will require a CFD broker for you to enjoy your trading activities. Pick a CFD broker that you feel aligns with all your trading requirements to have a worthwhile trading experience. Once you have identified a CFD broker, you will follow the steps below to trade CFDs.
- Learn About CFD Trading
They say “knowledge is power”, and so you should learn everything about CFD trading before you start risking your money. Many CFD brokers have learning resources, including a demo account that you can use to practice what you have learned. Once you feel ready and confident, you will create a live trading account and try your luck at making profits.
- Choose a Tradable Instrument
CFD brokers should have various assets for CFD trading, including the ones that you wish to trade. These assets include forex, stocks, cryptocurrencies, commodities, ETFs, indices, and more. Ensure that you are fully knowledgeable about the CFD asset you choose for easier market analysis and strategy.
- Identify Your Strategy
Like trading other assets, CFDs have various strategies to trade with. Ensure that you identify the best strategy based on your level of experience. This is so that you can quickly identify your entry and exit points.
Examples of common CFD trading strategies include leverage trading, swing trading, day trading, scalping, and more. Once you have gained a lot of experience trading CFDs, you can also create your own strategy and use it to trade successfully.
- Open a Position
Having identified the best strategy and assets for CFD trading, it is time to open a position. Based on your research, you can decide to either go short or long on a trade.
- Monitor Your Activities
CFDs are volatile instruments, meaning that their prices tend to change more frequently, hence affecting the underlying asset. For this reason, you should keep track of your trading activities so that you can identify when such changes occur and manage them on time before they get to affect your trade.
If you are a trader who is always on the move, consider installing a broker’s trading app on your mobile device. This is so that once you have opened a position, you will easily track your activities even on the go.
CFD Risk Management
Trading CFDs is more lucrative than trading physical assets with the right strategy. This is because it carries high leverage that allows you to trade with more than your initial capital and earn a lot of profits should a trade go against you.
However, have you ever thought about if the same trade does not favour your strategy? Well, that’s right. You will lose a lot of money that can bring a massive setback to your overall trading activities.
Note that there are ways you can manage your trade and prevent it from incurring huge losses. First of all, you have to be fully knowledgeable about CFD trading to reduce your chances at profits. You can also apply risk management controls like stop-loss orders.
A stop-loss order will control your CFD trading risk by automatically closing your position once it reaches a certain point of loss. This also eases your monitoring activity since you will not have to frequently keep track of your trade.
A stop-loss order can either be standard or guaranteed. Standard and guaranteed stop-loss orders perform the same functions. The only difference is that a guaranteed stop-loss order will stop your trade regardless of market volatility or gapping.
In contrast, the standard stop-loss order will not completely protect the risks since it is bound to slippage in case of high market price performance. For this reason, while a standard stop loss can protect your trade from extreme losses, it is best to go for the premium guaranteed stop-loss order.
CFD Trading Accounts
Trading CFDs require you to identify the best broker that suits your needs. CFD brokers offer you the platform to access diverse markets and choose what fits your strategy.
You either need a demo or live trading account to trade CFDs with a broker. A demo account works the same way as a live trading account. What differentiates them is that a demo account is risk-free, and you will not invest your trading funds with it.
Simply put, traders use demo accounts to test a broker and practice CFD trading until they are ready to venture into the real markets. Then, once you feel confident in your skills, you can create a live trading account and trade CFDs.
Note that brokers’ accounts differ, and based on your skills level, you should choose what will make you enjoy your trading experience. Examples of such trading accounts are the standard, cTrader, MT4, and MT5.
We hope that this guide has made you understand CFD trading, and you can now try your luck trading. To summarise it all, ensure that you stick to what you know. We mean that you should trade with the assets you are fully familiar with, and when you have gained confidence, you can then diversify a bit more.
Additionally, start small by risking a small percentage of your total capital in a trade. This prevents you from losing huge amounts of money, and you can also learn from your mistakes. We can advise you to start with 1-2% of your capital so that even when you lose multiple times, your capital won’t be affected that much.
Lastly, do not forget to apply for the stop-loss order because this is what experienced or professional traders do. Also, conduct thorough market research and stay abreast with the trending news on CFD assets.