Contracts for Difference (CFDs) are financial derivatives that let you speculate on price movements in global markets without owning the underlying asset itself. CFDs, explained simply, refer to a contract for difference between you and a broker. With this CFD contract, you agree to exchange the difference between an asset's price when you open the trade and when you close it, rather than taking delivery of shares, commodities, indices or currencies.

Because trading in CFD allows you to go long (buy) or short (sell), you can potentially profit from both rising and falling markets if your CFD analysis is correct. CFD trading markets are quite liquid, with the global retail FX/CFD industry recently reporting average monthly trading volumes above 30 trillion US dollars, which creates frequent trading opportunities for CFD traders as long as they manage risk carefully.

ThinkMarkets supports CFD online trading with its ThinkTrader ecosystem, a fully synchronised CFD trading platform available on web, mobile app and desktop, so you can analyse, place and manage trades seamlessly across devices.

Key learnings:

What is CFD, the derivative trading product where the price of an asset moves but not the asset itself.
CFD trading gives you the ability to go long (buy) or short (sell) and profit (or lose) from both directions.
You can control large market positions with a relatively small initial deposit through CFD leverage (though this increases risk).
You can trade thousands of CFD markets, including forex CFDs, commodities, indices, and shares, from a single account.

Interested in starting to trade the global markets? Open a ThinkMarkets Account today.

What is a CFD in trading?

A CFD in trading is a type of derivative instrument that tracks the price of an underlying market, like a share, an index, a commodity, or a currency pair, but doesn't give you ownership of that asset.In practice, a CFD in trading can be summarised as an agreement between you (the CFD trader) and your CFD provider (the CFD brokerage). This allows you to settle in cash the difference between the open and close price of your position, multiplied by your position size.

The CFD meaning in trading is entirely linked to the underlying market. If the asset moves in your favour, the broker pays you the difference, whereas if it moves against you, you pay the broker. A big difference between CFDs vs stock investing (the traditional type) is that you never receive share certificates, voting rights, or the physical delivery of commodities because CFDs are over-the-counter (OTC) products that only replicate price movements.

The CFD mechanism operates as follows:

Price moves in your favour: The broker pays you the difference.
Price moves against you: You pay the broker the difference.

Imagine you open a "buy" position on gold at $4,000 per ounce and close it at $4,050. You receive the $50 difference multiplied by your position size. Conversely, if the price falls to $3,950, you would incur a $50 loss per unit.

Trading academy forex both going long and going short are possible when trading CFD

Key CFD trader terminology

To fully understand what CFD means, you need to know the specific terms used in the trading field. These CFD trading basics dictate the cost and mechanics of every trade you place, so they are mandatory to learn.

Spread

The spread is the difference between the 'Ask' and the 'Bid'. The 'Ask' price is the price you buy an asset at, and the 'Bid' price is the price you sell an asset at. The difference in price shows what the cost of the trade is. Tighter spreads generally result in lower trading costs, which is important for short-term CFD strategies.

Lots and contract size

In trading CFD instruments, assets are exchanged in standardised amounts, known as lots. The size of a lot depends on the asset class. For example, a standard lot in forex trading CFD is 100,000 units of the base currency. However, to accommodate different trader profiles and risk appetites, CFD brokers often offer mini lot and micro lot accounts.

Swap and overnight fees

If you keep a CFD contract open after a certain time, usually 11 pm or 12 am GMT, you will have to pay a swap or overnight fee or receive a credit. This fee is the cost of holding the CFD position overnight, but it can be charged or credited to your account depending on the interest rate differential between the assets you are trading.

Pip and point

A pip (percentage in point) is the smallest standardised unit of price movement. For most currency pairs, a pip is the fourth decimal place (0.0001). For example, if EURUSD moves from 1.1700 to 1.1701, it has moved 1 pip. For instruments like index CFD markets, however, a point typically refers to a one-unit movement in the CFD index value.

How does CFD trading work?

How CFD trading works revolves around two primary mechanics: the direction of the trade and the use of leverage. These features allow for diverse CFD trading strategies that are not possible in traditional investing.

Long vs Short CFD

In CFD trading, you are not limited to buying low and selling high.

Going long (buy): If you think the price of an asset will increase, you open a "buy" position. You profit if the market moves up. This method is in line with traditional fundamental analysis methods that look for assets that are undervalued or buy due to positive economic drivers.
Going short (sell): If you think the price of an asset will decrease, you open a "sell" position. You profit if the market moves down. In traditional share trading, you can't short-sell because you have to own an asset before you can sell it.

Understanding leverage in CFD trading as well as margin

CFD leverage is one of the most powerful but also dangerous features of trading. Leverage allows you to control a large market exposure with a relatively small deposit, known as margin. For instance, if you had to put up 5% of the value of your position (20:1 leverage), you could control a $10,000 position with only $500 in your CFD trading account.

The math is simple. If you wish to open a position worth $20,000 on the S&P 500 index with a 5% margin, you need a deposit of $1,000 as collateral. The remaining $19,000 is borrowed from your CFD online broker, meaning you would be able to diversify across multiple positions or access pricey assets that would otherwise be impossible to afford.

Trading academy forex how margin trading works in relation to leveraged products like CFDs

Warning: CFD leverage is a double-edged sword that can increase profits as much as it can increase losses. If the S&P 500 moves against your position by 5%, you would lose your entire $1,000 deposit, especially if markets move against you fast. This is why risk management tools such as stop-loss orders are essential parts of any trading strategy. Understanding CFD risks is fundamental before committing capital.

What is the difference between investing in shares and CFD trading?

The difference between investing in shares and CFD trading is that share investing focuses on long-term ownership and wealth building. On the other hand, CFDs are typically used for shorter-term speculation or hedging without any ownership of the underlying asset.

In traditional investing, you buy shares outright, gain shareholder rights and usually pay the full value in cash, so your exposure is one-to-one with your capital. CFD vs investing, on the other hand, means that you only put down margin, trade with leverage, can go long or short, and hold a derivative contract that follows the price instead of owning the asset. This changes both your risk profile and the amount of time you usually hold the contract.

Below is a comparison of the key differences:

Trading academy forex contract for difference trading vs investing in shares

Both investment vehicles give you access to financial markets, but they have very different uses and require different skills. Traditional investing suits individuals building retirement portfolios, whereas CFD trading appeals to active traders seeking to exploit short-term price inefficiencies.

Ready to access over 4,000 markets from your mobile? Download ThinkTrader now.

CFD markets you can trade

One of the significant CFD benefits is the ability to access an extensive array of global markets from a single, CFD trading platform.

CFD forex

The foreign exchange market (forex) is the most popular arena for CFDs. You can trade major, minor, and exotic pairs. Because currencies often move in small increments, the high leverage available in CFD currency trading makes them attractive to day traders.

CFD indices

CFD indices allow you to speculate on the performance of an entire sector rather than picking individual stock CFD trading. Popular indices include the US S&P 500, the UK's FTSE 100, and the German DAX. These provide a broad market view and are excellent for those who want to trade based on macroeconomic trends.

CFD stocks or shares

You can trade share CFDs on thousands of global stocks across the US, UK, EU, and Australian markets. Unlike buying physical shares, which requires paying the full asset price upfront, share CFDs allow for fractional trading and leverage.

CFD commodities

Commodities like gold, silver and oil are staples in the CFD market. Traders often use CFDs on gold as safe-haven assets, as a hedge against inflation or when geopolitics takes a turn.

How to trade CFDs: Step-by-step

How to CFD trade with ThinkMarkets, a regulated broker, requires a plan that includes analysing the market, managing risk, and following through with your trades. Follow this simple six-step CFD trading system to place your first CFD trade:

Trading academy forex how to trade CFDs long CFD position or short with ThinkMarkets

Step 1: Choose to trade a CFD market

Choose the trading instrument you want to trade. It could be a currency pair like EURUSD, gold CFD trading, or a share in a company.

Step 2: Analyse the underlying asset

Before entering, you must analyse the likely direction of the price.

Fundamental analysis: Fundamental analysis involves looking at economic indicators, news, and earnings reports, with the analysis type depending on the asset.
Technical analysis: Technical analysis involves studying charts and patterns to predict future price movements.

Step 3: Decide trading strategy: Go long or short

Based on your analysis, decide if you want to speculate on the price going up (buy a CFD by going long) or falling (sell a CFD by going short).

Step 4: Set position size & calculate trading on margin

Determine how many lots you want to trade. Make sure you have enough money in your trading account CFD to meet the margin requirement.

CFD calculation:

Trading academy forex margin trading formula ThinkMarkets

Step 5: Execute the CFD trade

Open the CFD trade through the top CFD trading platforms, TradingView or ThinkTrader, or your CFD trading app.

Step 6: Manage the open trade

Once the CFD trade is live, you must monitor it. It is important to use risk management tools.

Stop loss: A pre-set order to close the trade at an exact price level if the market moves against you, limiting your loss.
Take profit: A preset order to close the trade when the price reaches your profit target.

Traders should also be aware of execution risks, such as price slippage, which can occur during periods of high volatility.

Gold CFD trading: Example of a CFD trade

Imagine you want to buy CFDs on gold at $4,045 with one standard lot. Generally, one standard lot is equivalent to 100 ounces of gold, where each tick price movement (0.01 difference in price) is worth $0.01. In this case, it would be $1 per tick, given the number of ounces (100).

Here are the other parameters for this CFD example, including the potential profit and loss amount based on the opening and closing prices of an example gold strategy:

Opening price: $4,045
Target price: $4,380 (33500 ticks from entry price)
Stop-loss price: $3,890 (15500 ticks from entry)
Profit calculation: $33,500
Loss calculation: $15,500

Trading academy forex CFD trading gold example daily chart

Advantages of CFDs vs disadvantages of CFDs

To fully grasp the contract for difference model, you must weigh the benefits against the risks. Although covered in prior sections, below is a summarised version.

Benefits of CFD trading

Go long & short: You have the flexibility to profit from a booming or crashing market.
Global access: From a single platform, you can do online CFD trading forex in the London session and CFD stock trading during the New York session.
No CFD expiry: Unlike futures or options, cash/spot CFDs do not have an expiry, so you can hold positions as long as you wish (subject to swap fees).
High leverage: CFD trading leverage provides capital efficiency, allowing you to diversify your capital across multiple trades.

Risks of trading CFDs

High risk: The primary CFD risk in trading is leverage. Just as it can boost gains, it can amplify losses that carry the potential to exceed your initial deposit (though ThinkMarkets offers Negative Balance Protection).
Trading costs: You must account for the spread and overnight swap fees, which can eat into profits if positions are held too long.
No ownership rights: You do not own the underlying asset, meaning you miss out on shareholder perks like voting rights and dividend payouts.
Demands risk management: Because markets move fast, advanced strategies like forex hedging are often necessary to protect your capital.

Trading academy forex CFD benefits vs CFD risks

Why trade CFDs?

Why do traders choose CFDs over traditional investing? The answer often lies in the barriers to entry and flexibility.

Low starting capital: You don't need the full value of the asset to start a trade because of CFD margin trading. This makes it much easier to get started than in traditional stock markets.
Flexible lot sizes: The best brokers for CFD trading enable mini and micro lot accounts. This precise sizing means you can tailor your risk exactly to your risk profile, rather than being compelled to buy expensive shares.
Large market exposure: Traders can gain exposure to expensive assets, such as gold or high-value indices, with a fraction of the capital needed to buy the physical asset.

Features of ThinkTrader: Speed and information are often key to success in FX CFD trading. The ThinkTrader CFD platform includes advanced screeners and real-time news feeds that assist in identifying these opportunities efficiently.

Although CFD trading can be beneficial at times, trading in general comes with a high risk of financial loss.

Not convinced? Practise your strategies risk-free on a Demo Account.

Start your CFD trading journey today with ThinkMarkets.

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