Let’s get started by looking at some basic information about CFD trading, what it involves, and some of the questions that traders often ask us.
What are CFDs?
CFD stands for Contracts for Difference.
They are a financial product offered by many brokers around the world.
In technical terms, CFDs are a ‘derivative,’ which means they allow traders to speculate on the price movement of various assets without actually owning the underlying asset.
In practical terms, when you trade CFDs you are simply trading on the price, and making a profit or loss based on the price increasing or decreasing.
For example, if you buy a CFD of an Apple share (AAPL), and it goes up by $1, then you will have made $1, without ever having to buy an AAPL share on the exchange.
Conversely, if the price of AAPL went down $1, you would have lost $1. This makes access to a variety of markets very accessible.
Also, note that CFDs are not like options or futures where there is an expiry date – a common misconception.
They simply follow the price movement of the underlying market.
Don’t worry if all this sounds a little bit complex at this point.
Despite the terminology, CFDs are quite simple to trade in practice. Don’t let the term ‘contracts for difference’ scare you.
Once you’ve set up your trading account and started trading, there are no contracts to sign each time you want to make a trade!
For more information on CFD trading, visit our page ‘What is CFD Trading?’
What are the benefits of CFD trading for beginners?
CFD trading offers many benefits for beginners. This is why it has seen millions of traders choose CFD trading over traditional assets.
Some of the benefits of CFD trading include:
- Cost saving – commissions or other costs associated with trading are often significantly cheaper than buying the asset directly
- Leverage – Leverage allows you to take a larger position with a smaller amount of capital, potentially amplifying your profits (but also magnifying your losses)
- Single trading account – you can trade multiple assets from the same trading account
- Shorting – You can profit from price declines, not just price increases, by making short trades. This means you can make money when the asset declines in value, as opposed to when the price goes up
- Simplicity – as you don’t hold the underlying asset, trading CFDs can be simpler than buying the underlying asset outright. For example, if you want to trade bitcoin (BTC) you can do so without having to set up a crypto-wallet.
It’s important to note that CFDs can incur financing costs if you hold positions overnight.
While these are normally minor compared to the profit and loss on the trade itself, it does mean that if you are a long-term investor, buying the underlying market directly may be a better option.
What markets can you trade as CFDs?
A wide range of global markets are accessible to traders through CFDs, offering significant diversity and flexibility, depending on your preferred trading style. These markets include:
- Foreign exchange (forex)
- Stock market indices
- Commodities
- Individual stocks
- Shares
- Cryptocurrencies
This expansive selection allows traders to tailor their trading activities to best suit their preferred trading approach and is one of the main reasons for the popularity of CFDs.
How leverage works when trading CFDs
Leverage lets you take a larger position in an asset than your trading capital would normally allow you to do.
CFDs have leverage ‘in-built’ so that anytime you take a CFD trade only a portion of the value of the trade is required.
This does not mean you have to make use of all the leverage available in your trading account.
Successful traders will limit the size of their trades based on their risk management rules.
Think of leverage as a tool you can use if you so choose – one that should be used with a great deal of caution.
Here’s a breakdown of how leverage works:
Traditional trading vs. CFD trading with leverage:
You believe the price of gold will increase and decide to trade a Gold CFD offered by a broker with 10x leverage. The current spot price of gold is $1,800 per ounce.
Traditional gold trading:
If you bought one ounce of physical gold directly, you’d need $1,800 upfront. If the price rises to $1,900 and you sell, you make a profit of $100. Your ROI would be approximately 5.5% ($100 profit / $1,800 investment).
CFD trading with leverage:
With 10x leverage, you only need $180 ($1,800/10) to control a position worth $1,800. This significantly reduces your upfront capital requirement.
Profitable scenario:
- If the price increases to $1,900 like before, you make a profit of $1,000 (10x leverage * $100 increase per ounce).
- Your ROI would be 555% ($1,000 profit / $180 investment).
- In this scenario, leverage amplifies your potential gains compared to traditional trading.
Losing scenario:
- If the price goes down to $1,700 instead, you lose $1,000 (10x leverage * $100 decrease per ounce).
- This loss exceeds your initial investment of $180.
In this scenario leverage also magnifies your losses compared to traditional trading.
Important to remember:
- Leverage magnifies both profits and losses. A small adverse price movement can wipe out your capital due to margin calls if you are not careful in managing the size of your trades.
- This is a simplified example, and real-world scenarios involve additional risks like overnight financing charges and commissions.
Food for thought:
Think about how trading using leverage magnifies your potential profits, but also magnifies your potential risks. Are you comfortable taking this risk?
How short trading works
When you ‘short’ or ‘sell’ a CFD, you profit from the price going down rather than up. Conversely, if the price goes up you would lose money.
Let’s look at how an example of a short trade on a CFD on gold would work:
Assuming you went short one ounce of gold valued at $1,800:
Profitable scenario
If the price falls to $1,700 and you close your trade, you make a profit of $100.
Losing scenario
If the price rises to $1,900 and you close your trade, you make a loss of $100.
For experienced traders, who are new to CFDs, it’s important to note that you don’t need to go through the process of borrowing an asset to short it as a CFD. Rather you are taking a position based on your expectation of the price falling.
CFD trading is 24 hours a day, 5.5 days a week
The buying and selling takes place in financial markets located around the globe. The financial markets are based in the major financial centres of the world such as:
- London
- New York
- Singapore
- Hong Kong
- Tokyo
- Shanghai
- Zurich
- Frankfurt
- Paris
- Sydney
Due to international time differences, it is possible to trade online almost any hour of the day or night, depending on where you live, and which markets you have access to through your trading platform.
The trading day begins in the east, in Sydney, Tokyo, and Hong Kong, and gradually shifts around the globe, ending in the west of the US.
But just as the US markets close, so the eastern markets prepare to open again and so the cycle continues 24/5.5 around the world.
The importance of charting
Most traders decide what to buy and sell by looking at trading charts.
This applies to all varieties of CFDs, including FX, indices, crypto, shares, or commodities.
The great news is, once you learn how to read what charts are telling you, you’ll be able to trade almost anything.
Short-term traders, also known as day traders, who may buy and sell daily, are usually more interested in charts that show price action over a short period, such as minutes, hours, and days.
Longer-term traders may want to know the price action over the past weeks, months or years.
What do charts tell us?
The fascinating thing about chart patterns is that certain patterns develop on the chart as the price action moves up and down each day.
These patterns repeat themselves over and over again.
Studying these patterns, and interpreting what they mean is a field of study known as technical analysis.
Here is an example of a trading chart with a steady price channel, and then a sudden breakout before the start of a new uptrend.
Most online traders use chart patterns to decide when to enter a trade. Traders commonly refer to these as entry and exit points.
Once you have learned to recognise well-known chart patterns and trends, you have the basic tools and knowledge to trade almost any market. The basic skill is the same, giving you a wide range of options for your trading endeavours.
Developing a trading plan
As a trader, your job is to decide in advance what chart patterns you are going to trade.
This could be written down in a document known as a trading plan. In your trading plan, you are going to decide on your entry point, and an exit point, and how much money you are going to place on the trade (which is referred to as your position size.)
You can find out more about how to write a winning trading plan here.
Commonly asked questions about trading CFDs
Here are a few frequently asked questions about starting online CFD trading:
What do I need to start trading?
All you need to start trading is a reliable computer or smartphone, and an internet connection.
You will then need to spend some time learning the markets. This could be from a friend, a mentor, a course, or by joining a community of traders.
Ultimately, nothing beats getting some live trading experience, so starting a small trading account to take some initial positions can be a good idea.
Alternatively, you can use a free demo account – but be aware – trading demo money is not the same as trading real money!
Do I have to be smart to trade?
No, you don’t need to be an Einstein or an Elon Musk to trade, but you will need basic computer skills.
More important than smarts is emotional control.
Good traders learn to stay cool under pressure. This topic is called trading psychology.
How much money do I need to start trading?
This is a very personal question, as it depends on an individual’s financial situation. Here are a few considerations:
- Are you risking the money you need for day-to-day living? Your trading capital should be additional funds you have set aside for trading or investing and not what you require for day-to-day living.
- Can you sleep at night? If you are worried or distracted by the size of your trades, they may be too large.
- Do you have enough capital to place the trades that you want to take? Make sure you have enough funds in your account to take advantage of the opportunities you see in the market.
- Can you practice proper risk management? Successful traders practice disciplined risk management. Make sure you have enough funds in your account that a few losses in a row won’t knock you out of the market. A rule of thumb is not to risk more than 1% or 2% of your account on any one trade.
When can I do my trading?
The beauty of online trading is that it gives individuals the flexibility to trade at a time that is convenient for them.
It’s possible to trade ‘something’ almost 24/7 regardless of where you live around the world.
This means you can fit your trading around other life commitments like work, study, and family.
Regardless of the time zone you live in, there will be a financial market open somewhere in the world that you can access via your online trading platform.
Is trading risky?
Trading necessarily means taking a risk, because by buying a CFD, you are hoping that it will increase in value so you can make a profit when you sell it. Of course, sometimes this happens and at other times it does not, meaning you will end up taking a loss.
What is important is that you practice risk management, so if you have a loss it is only a fraction of your account.
So yes, trading is risky, but you have tools to help you manage that risk.
Trading is a journey
Like mastering any complex skill, you are not going to master the markets overnight.
Unlike get-rich-quick schemes, trading is a marathon, not a sprint. There will be bumps in the road, and it will require perseverance and courage to become a successful trader.
As trading has such a large psychological component, trading offers not only financial benefits but personal ones too.
Mastery of the markets in many ways requires mastery over yourself, leading to personal as well as financial growth. You’ll develop discipline, self-awareness, and resilience – skills that benefit every aspect of life.
We encourage you to embrace and enjoy the journey.
View trading mistakes as an opportunity to learn.
Review and analyse your trades carefully, seek guidance from mentors, and celebrate even small victories.
It will be worth it!
If you would like further information, read my trading course for beginners. This will help you further along in your trading journey.
I wish you safe and happy trading!
Glossary
Here’s an explanation of some common FX trading words:
ASX – the Australian Securities Exchange, Australia’s stock market
BC – base currency, the first currency in a pair
Brokerage fee – a fee you pay to a stock broker or brokerage site each time you use their platform to buy or sell an asset
Bear market – describes a market environment in which the majority of prices are falling
Bull market – an optimistic market in which most prices are rising
Cable – a slang market term for one of the most popular currency pairs – GBP/USD
Carry trade: A strategy where a trader borrows in a currency with a low interest rate and invests in a currency with a higher interest rate to profit from the interest rate difference
CC – counter currency, the second currency in a pair
CFD – a ‘Contract for Difference,’ which is a type of derivative financial product that is traded based on the value of an underlying asset such as a currency pair or company share or cyptocurrency
Correlation: The statistical relationship between two assets, for example two currency pairs, indicating how they move in relation to each other – either positively, negatively, or not at all
Cryptocurrency – a form of virtual currency which only exists in the cyber world. Cryptocurrencies can also be traded online through CFDs in a similar way to standard FX trading
CPI – Consumer Price Index, which reflects the inflation rate of a particular country, and is a very important market indicator in FX trading
Day trading – a trading strategy that involves buying and selling shares in one day, and closing all positions before the end of the trading day
Derivative – a financial product that is based on the underlying value of another asset. CFDs, options and futures are all examples of derivatives
Forex brokerage: A company or platform that provides access to the forex market, facilitating the buying and selling of currencies for traders
Forex or FX trading – foreign exchange trading, converting one currency to another in order to profit from price changes
Futures contract – a contract to buy or sell an asset at a specified future date for a specified price
Greenback – a FX slang term for the American dollar, based on the colour of American $1 notes
Hedge – an investment strategy designed to offset or reduce your exposure to risk. It is related to the phrase ‘hedging your bets’
Leverage – using ‘borrowed’ money to invest so you can trade a larger position with less initial outlay. Most FX brokers offer leverage starting from 5% up to 60% or more
Loonie – the slang FX market term for the Canadian dollar (because Canadian dollar coins formerly pictured a loon on them)
Margin: The amount of money required to open and maintain a leveraged position, often expressed as a percentage of the total trade size
OTC – ‘over the counter’ – which describes the global forex market method of operation, where there is no centralised exchange, but rather trades take place directly between two parties through an electronic network connecting traders all over the world
Share trading – buying and selling shares in public companies through a stock exchange
Short trading: Selling an asset with the intention of buying it back later at a lower price to profit from a reduction in the price
S/R – support/resistance. This describes specific price levels using technical analysis on a trading chart. Support is a level below the current price which has previously acted as a floor or lowest selling point. Resistance is a price level above which the price has previously shown reluctance to climb
Slippage – The difference between the expected price of a trade and the actual price at which it is executed,with the difference often due to market volatility or delays
SL Order – Stop loss order – a type of trading order which automatically kicks in at a certain price and closes a trade to prevent catastrophic loss
Sterling – another name for the British pound
Swap fees: Costs incurred when holding a position overnight, related to the interest rate difference between two currencies in a forex pair
Take a Position – this describes the action of opening a trade – you are said to ‘take a position’ when you choose to open a trade
TP Order – Take profit order – a price order which is set which automatically closes a position to take the profit made on that trade
Volatility – a measure of how much the value of a particular asset fluctuates on a regular basis
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Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Dr Van K. Tharp – Super Trader: Make consistent profits in good and bad markets. https://www.amazon.com.au/Super-Trader-Expanded-Van-Tharp
- Sam Eder – The Consistent Trader. https://www.amazon.com.au/Consistent-Trader-Winning-Trading-Psychology/
