In order to trade CFDs, you first need to find a CFD broker. Acting as the ‘bridge’ between you and the market, these brokers provide you with access to their trading platforms for trading CFDs online. A CFD trading platform, then, is the interface provided by brokers that traders use to buy and sell CFDs. These trading platforms are frequently offered as web browser-based platforms, software downloads and mobile apps.
Like any other derivative securities, the risk of trading CFDs is relative to each individual trader’s risk/reward appetite. The appeal of CFDs lies in the fact that they allow you to trade using leverage, or margin. Leverage allows you to ‘borrow’ money from a broker in order to increase your position size on an instrument.
Confused? Let’s take a look at an example:
Let’s say you buy £10,000 of Tesla shares from a broker using CFDs. Your broker, for this example, offers leverage (or margin) of 10:1. However, you only tie up £1,000 of your own money; the broker ‘borrows’ you the remaining £9,000. In this situation, a much smaller sum of money (£1,000) is controlling a much bigger financial position (£10,000).
While leverage magnifies your profit potential, on the other hand, it also increases your exposure to risk and potential losses. As a result, it’s important to understand Risk Management and develop methods to minimise risk.
In addition, many CFD providers offer negative balance protection to help protect traders. Negative balance protection ensures that you will never lose more than your initial deposit and be in a position where you owe money to a CFD broker.
So, overall, CFD trading is safe – as long as you’re aware of the risk/reward potential and have a robust risk management plan in place.
A wide range of asset classes is available to trade as CFDs, including:
However, the exact instruments available to trade varies from broker to broker, so it’s worth checking in advance if a broker offers your preferred financial instrument. For example, while Forex CFDs are commonplace, not every broker offers ETF or Indices CFDs.
In addition, you’ll find that some CFD platforms offer more choice within certain CFD categories. For instance, IG is known to have the widest selection of tradable stock CFDs among all brokers while CFD brokers such as XM are known more for their Forex offering.
So, what are the benefits of CFD trading? Let’s take a look at some of the reasons why CFDs are popular among traders:
Like most complex financial derivatives, with the exception of spread betting, CFDs are subject to Capital Gains Tax, or CGT. However, CFDs are exempt from the Stamp Duty Reserve Tax (SDRT) in the UK, currently payable at around 0.5%. What does this mean? Put simply, you don’t have to pay ‘Stamp Duty’ when you buy or sell Contracts for Difference.
The ability to trade both ‘long’ and ‘short’ positions, i.e. buy or sell, allows you to capitalise on potential price movements in both directions. For example, short-selling allows you to profit when the price of the underlying asset drops in value and is a good way of taking advantage of potentially overvalued stocks and short term fluctuations.
CFDs provide you with exposure to a broader range of tradable assets including commodities, ETFs, indices and bonds. This provides you with useful versatility in the market and the ability to diversify your portfolio across multiple asset classes.
CFDs are a leveraged product, which means you only need to deposit a percentage of the total value of the trade.
Despite the apparent benefits, CFDs are not entirely risk-free. There are several potential risks and drawbacks that aspiring traders need to be aware of:
Leverage is something of a double-edged sword for traders. While it does increase your profit potential and reduce capital requirements to get started, high leverage does not guarantee higher returns.
It is important to be aware of the risks of complex leveraged products. For instance, leverage also increases your potential for losses and exposure to risk. For this reason, it is vital to set stop losses and protect yourself against market volatility.
Intrinsically linked with leverage is the concept or idea of ‘overtrading’. Because of the fact that CFDs are a low-cost way to access markets, it’s easy for traders to overtrade. Overtrading is when a trader veers away from a disciplined CFD trading strategy and unnecessarily exposes themselves to risk.
Also known as ‘swap fees’, many CFD providers charge a fee for maintaining an open position overnight. In simple terms, an overnight fee is an interest payment charged in order to cover the cost of the leverage you use overnight.
The most common way many CFD brokers make money is through the bid-ask spread and commission fees charged on a per-trade basis, as well as numerous non trading-related fees such as overnight funding, inactivity and currency conversion fees. Many brokers claiming to offer ‘commission-free trading' typically end up making their money by widening the spread on trades. Learn more about how brokers make money in our guide to brokerages fees.
CFDs allow you to trade on price movements within financial markets such as stocks, commodities, indices and currencies. When you buy CFDs through a CFD broker, you don’t actually own the underlying instrument. In addition, when you buy a CFD you don’t have to pay the full value of the position. Instead, you pay a fraction of the position – also known as ‘trading on margin’.
With a plethora of CFD providers competing for your business, how do you determine who the best CFD broker is? Here are a few things to bear in mind:
For many traders, regulation and security are often front-of-mind when comparing CFD trading platforms. It is important to find a CFD broker that is fully regulated by one or more of the leading regulatory bodies around the world. These regulators maintain an important system of checks and balances and exist to help protect traders. All of the best CFD trading platforms will be overseen by at least one of these regulators, including:
Look for CFD providers that offer a number of ways to fund your account including bank transfers and e-wallets such as PayPal, Neteller and Skrill. More payment methods means more ways to deposit and withdraw your money, and unfortunately not every broker is as up-to-date with this as ought to be.
As a trader, there’s nothing worse than waiting to get your hands on those hard-earned profits. Unfortunately, not every CFD platform is created equal and some will make you wait longer than others. Withdrawal times vary from broker to broker, so while some may offer instant payment processing, others can take anywhere between 1 and 3 business days to process your request..
The initial deposit you’ll need to make depends which broker you choose. While some have account minimums of £200, others allow you to start trading with no minimum deposit requirements. While no minimum deposits sounds appealing at first, it’s important to weigh up benefits across the board when comparing CFD brokers.
As we already know, most CFD providers make their money off the bid-ask spread and commission fees. Look for a broker with tight spreads and remember that zero-commission trading never means zero-commission.
It’s also worth comparing the non-trading fees that are a common banana skin for traders such as overnight funding and inactivity fees. These fees are often buried deep in a broker’s terms and conditions and can lead to unexpected charges that quickly add up. Save yourself stress further down the line by choosing a broker that is transparent about the fees they charge.
When it comes to trading platforms, brokers are more or less split down the middle between those that offer support for third-party platforms such as MetaTrader and those that don’t. If you’re someone who prefers using MetaTrader, it’s worth looking at brokers that support MT5.
However, if you don’t mind, the good news is that many brokers offer CFD trading platforms that come fully equipped with an arsenal of trading tools. Another thing to consider is your own ability level and what you need from a trading platform. Are you an experienced trader that frequently makes use of technical analysis tools and add-ons such as economic calendars? Or are you new to the world of CFD trading and looking for a platform that is more suitable for beginners?
Some key questions to be asking yourself include:
While some brokers are proud of their award-winning customer service, others are less interested in providing after-sales support once you’ve opened an account with them. For some traders, customer support is an integral part of their rationale for choosing a CFD provider. Even if this isn’t a priority for you, support should be available 24/5 and there should also be a variety of ways to get in touch with the customer service team. If English isn't your native or preferred language, many of the best CFD brokers will offer multilingual support.
Frequently overlooked when many traders compare CFD brokers, access to a library of educational content is particularly valuable for new and inexperienced traders. Many brokers provide their clients with access to a wealth of educational resources, from how to use their trading platform to how to make your first trade and more. If you’re just getting started and wondering where to head first, you’ll often find that guidelines on basic and more advanced CFDs trading approaches are massively helpful for first-time CFD traders.