How do I make money trading CFDs?

[Sam Button]

[Sheila Olson]

Contracts for difference, or CFDs, are derivatives, which means you can make money off the price movement of an underlying asset without actually having to buy or sell it. You can trade CFDs in much the same way you would stocks, and because you don’t own the underlying instrument, you can short CFDs without incurring borrowing costs. Another huge advantage with CFDs is the use of leverage. With margins as low as 5%, you can control a large position with a relatively small capital outlay. There are no special day trading requirements and you can open a CFD trading account for $1,000, although some brokers have larger minimums in the $2,500 to $5,000 range. You profit on CFD trades in the same way you would if trading the underlying instrument. Unlike spread betting, where you’re betting on the point movement of the asset price, CFDs closely mimic the underlying asset transaction. In other words, you can buy or sell CFDs share-for-share. If you are bullish on the underlying asset, you go long on CFDs. If you believe the price will fall, you simply open a short contract. It’s a very simple and straightforward process compared to shorting equities with your broker. Although you can use CFDs for medium- and long-term investing, they are particularly well suited to day trading, especially because there are financing costs associated with holding an open position overnight. One thing to keep in mind about CFD trading is that the trader pays the spread, so you need to factor those costs into your profit target. When you go long, you pay the bid price, and when you exit the trade, you receive the ask price. Spreads vary by broker and by underlying asset. Spreads will be much tighter on highly liquid markets such as major stocks, stock indices, and popular forex pairs. Here’s how it works: Imagine you’re trading CFDs on the equivalent of the Dow Jones Industrial Average, with a spread of 20,620.5/20,621.9. You think the index will rise, so you go long on 10 CFDs. The value of your position is $206,219 and the margin requirement is 5%, or $10,310. The spread is 1.4 points, which means the underlying index must rise at least 1.4 points to break even. Later, you exit your position when the DJIA is at 20,680.4/20681.8, and the value of your position is $206,804. You made $58.50 per contract, or $585, a 5.7% profit on your trade. Note that when you trade CFDs on shares, you also pay a brokerage commission on your trades, which will affect your profit. Because you’re trading with leverage, it’s very important to set tight stops to limit your losses in case a trade goes against you.