CFDs (derivatives) have been around for a while. We'd like to categorize these as more complex financial instruments. This article will give you an overview of some key things to know when it comes to trading CFDs.
Let's jump in!
Key Takeaways
- CFDs let you trade on price movements without owning the underlying asset.
- You can go long (buy) or short (sell) depending on where you think the market is heading.
- Leverage lets you open larger positions with less capital, but it also amplifies your losses.
- CFDs are available on stocks, indices, commodities, forex, and cryptocurrencies.
- Always use stop-loss orders to help protect your capital, especially as a beginner.
CFD Related Terminology
CFD - a Contract for Difference is a popular financial derivative instrument (instruments whose value is derived from any underlying asset, which can include indices, commodities, currencies, equities, and more). CFD trading allows investors to speculate on the rise and the fall of volatile global markets without actually owning the underlying asset.
Initial margin - the minimum amount of money that is required to open a position.
Leverage trading - leverage is a concept that allows you to increase your exposure to a financial market without investing more cash. It can be used to profit from small price movements by having greater exposure to your capital.
Leverage ratio - is the amount of leverage provided by a broker to trade a leveraged product. The ratio is expressed as X:1, where X represents how much market exposure you get per unit of your own capital. For retail clients in the EU and Australia, leverage typically ranges from 2:1 (for cryptocurrencies) up to 30:1 (for major forex pairs).
Buying long - is when traders open a Contract for Difference position in expectations of a price increase. For example, when traders think that Apple's (AAPL) price will increase, they are opening a long position.
Selling short - is when traders open a Contract for Difference position in expectations of a price decrease. For example, when traders think that Tesla's (TSLA) price will go down, they are opening a short position.
Stop-loss (SL) - is a risk management order for investors and traders. Stop-loss is set by a trader at a specific price level at which the position is automatically closed in order to prevent additional losses. Stop-loss is strongly recommended on every leveraged trade and is considered best practice by most experienced traders.
Take profit (TP) - is an order to automatically close a position at a specified price level once your target profit has been reached. For a long (buy) position, the TP triggers when the price rises to your target. For a short (sell) position, it triggers when the price falls to your target.
Balance - it is the amount of money that a client has transferred to the margin account, not including results of currently open positions.
Equity - the account equity including results of currently open positions, or the total value of a margin account based on current market prices.
Margin - the amount of funds required to maintain open positions.
Free margin - the account's free margin amount or funds that can be used to open more positions.
Margin call - an event where the value of your account falls below the predetermined threshold. To trade freely, you must have a sufficient free margin in your account.
Important note: In the EU there is a mandatory close out rule which standardizes the percentage of margin (at 50% of minimum required margin) at which providers are required to close out one or more retail client's open CFDs. Read more from the European Securities and Markets Authority.
What is a CFD?
Simply put, a contract for difference (CFD) is a contract between a trader and a broker to exchange the difference in an asset's price between when the contract is opened and when it is closed. If the price moves in your favour, the broker pays you the difference. If it moves against you, you pay the broker the difference. CFDs enable traders and investors to profit from price movements without owning the underlying assets. The value of a CFD is determined solely by the price difference between the transaction entry and transaction exit.
It is a contract designed to profit from the difference in the price of a security between the opening and closing of the contract.
This is achieved through a contract between the customer and the broker; no stock, currency, commodity, or futures exchange is used. Unlike traditional investing, trading CFDs does not require you to own the underlying asset, which opens up more flexible opportunities for investors. Over the past decade, CFD instruments have become increasingly popular.
How CFD Trading Works
The CFD trading process is simpler than it might sound. Here is what happens from start to finish:
1. Choose your asset. Pick the market you want to trade, such as Apple stock, gold, or EUR/USD. You are not buying the underlying assets directly; you are simply speculating on their price movement.
2. Decide your direction. If the price rises, you open a long (buy) position at the current buy price. If the price falls, you open a short (sell) position.
3. Set your trade size and leverage. You only need to deposit a small percentage of the total trade value (called the margin). How much margin you need depends on the leverage level and the size of the position you choose. Leverage allows you to control a larger position with less capital.
4. Monitor your position. Track market prices in real time as your profit or loss updates with every price movement. You can set a stop-loss to automatically close the trade if it moves against you, or a take profit to lock in gains at a target price.
5. Close your trade. Closing positions are straightforward: the difference between your opening and closing price determines your result. If the market moved in your favour, you make a profit. If it moves against you, you make a loss.
That's it. No asset is bought or delivered. The CFD simply mirrors the price movement of the underlying asset.
Understanding Contract for Difference
When investing in stocks, bonds, or any other financial instrument, a trader will own the securities. CFD traders, on the other hand, do not hold any tangible assets. Instead, they trade on margin with units connected to a specific security price, based on its market value.
A CFD is the right to speculate on changes in the price of a security without actually having to purchase the security.
Leverage and exposure
The table is an example of leverages and exposure companies registered in the EU can offer to their customers – up to 30:1 leverage.
What You Can Trade With CFDs
The CFD market gives you access to five major asset classes:
- Stocks: Trade price movements of well-known companies like Apple, Tesla, Amazon, and Meta without needing to own the shares.
- Indices: Speculate on the overall performance of major stock markets, such as the S&P 500 or the Nasdaq.
- Commodities: Trade on the price of physical goods like gold, silver, crude oil, and natural gas.
- Forex: Buy and sell currency pairs such as EUR/USD or GBP/USD on the global foreign exchange market.
- Cryptocurrencies: Speculate on the price of digital assets like Bitcoin (BTC) and Ethereum (ETH) without owning them.
This variety means you can diversify across multiple markets and take advantage of opportunities around the world, all in one place.
Example of a CFD Trade
Below are two CFD trading examples that show the difference between buying stocks outright and using a CFD with leverage.
Trading Stocks
Martin is buying $11,500 worth of Apple stocks with the price of $115 per single share. He now has 100 Apple shares.
One month later, the stock price did reach $130. He then sold his 100 shares for $13,000, making a profit of $1,500.
The return on investment was a little bit over 13% of the initial amount invested.
Trading CFDs
Instead of just investing in Apple stocks, Martin now wants to leverage his trade to earn more money from that position. So he opens a long CFD position in Apple with 5:1 leverage.
Since the leverage is 5:1, Martin does not need to invest the whole $11,500 to get 100 shares of Apple stock. Instead, he uses the option of leverage and invests only $2,300 (11,500 divided by 5) in an Apple CFD. Now he has an open position size equivalent of 100 shares (without actually owning the shares). In other words, Martin gets the same market exposure with less initial capital.
One month later, the stock price peaked at $130, and Martin sold his long position in an Apple CFD, making $1,500.
The return on investment was a little bit over 65% of the initial amount invested, illustrating how leverage can significantly increase potential profits from a relatively small market movement.
As you can see, CFD trading allows you to allocate less initial capital to make the same returns as investing in stocks. It works the other way around as well: when a stock price moves in the wrong direction, losses are also amplified. This is why risk management is so important.
All CFD traders should use stop-losses, to prevent an exponential loss in capital.
Key Things to Know Before Trading CFDs
Here is a summary of the most important things every beginner should understand before placing their first CFD trade:
- CFDs involve leverage, which makes them more complex than regular investing. Take time to understand how they work before trading with larger amounts.
- A CFD investor never owns the underlying assets.
- A CFD investor earns or loses revenue based on the price change of the invested asset. For example, investors can speculate on the silver price movements when investing in a Silver CFD, and never own the asset.
- Traders can speculate on both ways: selling short or buying long.
- Most CFDs have no fixed expiry date and can be held as long as you maintain sufficient margin. However, some CFDs based on futures contracts (such as oil or natural gas) may have rolling dates or expiry. Always check with your broker.
- Less initial capital is needed.
- Possibility to earn higher returns.
- Losses can exceed your deposit: Leverage amplifies both profits and losses. Even a small market move in the wrong direction can result in a loss greater than your initial margin.
- Prices can move quickly: Markets can be highly volatile, especially during news events. Prices can shift within seconds, making it important to always have a plan.
- Not suitable for everyone: CFDs are complex instruments. Take time to learn and practise with smaller amounts before scaling up.
Managing risk as a beginner comes down to three core habits: using stop-loss orders on every trade, starting with smaller position sizes, and only trading with money you can afford to lose.
Pros and Cons of CFDs
Pros
Higher leverage
CFDs offer more leverage than traditional trading. Standard leverage depends heavily on CFD regulations, which change from time to time. For example, 50:1 leverage was once offered, meaning maintenance capital had to be only 2%. Today, however, it is limited to 30:1.
According to Financefeeds, European leverage limits are the following:
- 30:1 for major currency pairs (EUR/USD, GBP/USD, etc.)
- 20:1 for non-major currency pairs, gold, and major indices.
- 10:1 for commodities other than gold and non-major indices.
- 5:1 for individual equities.
- 2:1 for cryptocurrencies.
No shorting rules
Specific markets have rules that prohibit short selling or require the trader to borrow the instrument before selling short. However, CFDs can be short-sold at any time because the trader does not own the underlying asset.
Variety
Brokers offer stocks, indices, treasury, currency, and commodity CFDs. This allows speculative investors to trade in different markets and hedge their finances.
Can start with low amounts
CFDs offer leverage, allowing investors to use less initial capital.
Cons
Risks
Leveraged financial instruments are an excellent invention for traders to amplify financial gains. Unfortunately, leverage can also magnify losses.
Traders pay the spread
Traders pay spread from each position they take. During high volatility or fluctuations, the spread can be quite broad.
Overnight fees
This is the interest that traders have to pay for overnight financing on open positions. It is calculated based on the CFD value and is deducted daily for every day the trader keeps the position open. The fee is not charged if the trader closes the position on the same day (before the overnight fee time).
Varying level of regulation
In many countries, the CFD industry is not highly regulated, which means traders rely on a broker's credibility and reputation.
However, in the EU, the CFD industry is highly regulated and you can read more about the regulations from ESMA.
Margin call or liquidation
When trading with leverage, a margin call is possible. This results in significant losses in capital. Most times, traders can protect themselves by setting stop-losses, but in extreme cases, even a stop loss might not help.
CFDs vs. stocks
CFDs and Regulations
CFD regulations are constantly changing and vary by region and country. In countries like the US and Hong Kong, CFD trading is prohibited.
In the United States, CFD trading is prohibited because it goes against the Securities Law – restrictions made by the Securities and Exchange Commission on over-the-counter financial instruments.
The Securities and Futures Commission of Hong Kong has forbidden CFD trading. However, Hong Kong residents can still trade CFDs via overseas brokers.
Countries with outright CFD bans include the USA and Hong Kong. Brazil operates in a regulatory grey area - domestic brokers cannot offer CFDs, but Brazilian residents may access them through licensed overseas brokers at their own risk.
Countries where only regulated firms are allowed to trade CFDs: China, Thailand, Malaysia, Albania, some Latin American and Arabic countries.
In the European Union, CFD trading is allowed, some restrictions and regulations vary a bit by country. For example, Belgium has prohibited some forms of CFD trading, such as Binary Options.
Most European CFD providers are regulated by The Cyprus Securities and Exchange Commission (CySEC), though some operate under other national regulators - for example, Change Securities B.V. is regulated by the Dutch Authority for the Financial Markets (AFM). Service providers in the UK are regulated by The Financial Conduct Authority (FCA) in the United Kingdom.
The regulations of the regulatory authorities are mainly aimed at raising the awareness of traders to alleviate high-risk trading and protect traders' capital and privacy.
CFD regulations are constantly changing. More CFDs will likely be regulated in the future to provide greater protection for traders.
In the United States, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have prohibited CFDs from being listed on regulated exchanges due to their high-risk nature.
Conclusion
CFD trading is a flexible way to access global markets, go long or short, and make the most of your capital with leverage. As a beginner, focus on understanding how CFDs work, using stop-losses, and never risking more than you can afford to lose.
Ready to get started? Change is built with beginners in mind, with a simple interface and the ability to start with as little as EUR 10.
Start your CFD trading journey today with Change
FAQ of CFDs
Is CFD trading good for beginners?
CFD trading can be suitable for beginners who take the time to understand how leverage and risk management work. Start with small position sizes, always use stop-loss orders, and trade only with money you can afford to lose. The key is education before committing larger capital.
What’s the best CFD trading platform?
The best CFD trading platform is one that provides low fees, strong regulation, easy navigation, and clear risk-management tools for beginners. A platform like Change offers a beginner-friendly interface, fast execution, and access to multiple CFD asset classes in one place, making it suitable for new traders who want a simple and transparent trading experience. Starting with a demo account or opening a trading account with a small deposit can also help you see if the platform fits your trading style before committing more capital.
Is it better to invest in stocks or CFDs?
Investing in stock shares has lower risk and fewer opportunities to earn. With stock shares investing, one can only make a profit when the underlying asset price increases. Trading with stock CFDs opens up opportunities to leverage trades and also short stocks.
One is not better than the other. Every investor and trader must analyse their risk tolerance and strategy to understand which options, as mentioned above, suit them better.
Which CFDs are available in the Change app?
The app is user-friendly for novice investors but also offers enough opportunities for advanced traders. In Change, assets can be traded and invested in. In addition, Change offers users the opportunity to invest in cryptocurrencies, stocks, commodities, and indices.
Commodities CFDs
- Gold (x20 leverage)
- WTI Oil (x10 leverage)
- Brent Crude (x10 leverage)
- Silver (x10 leverage)
- Natural Gas (x10 leverage)
- Palladium (x10 leverage)
- Platinum (x10 leverage)
Indices CFDs
- Nasdaq (x20 leverage)
- S&P 500 (x20 leverage)
US Stocks CFDs
- Hundreds US stocks (5x leverage), including Apple, Amazon, Meta, Tesla
Forex CFDs
- Tens currency pairs (20x-30x leverage)
Cryptocurrency CFDs
- Tens crypto CFDs( x2 leverage), including BTC and ETH
Why should I choose the Change app?
- Our team have worked hard to make the user interface very customer-friendly. It is effortless to buy, sell, and navigate in the app.
- We have a professional and fast support team.
- We are constantly developing new features in order for clients to have more variety and options.
- Straightforward, honest, and open communication with customers.
- We prioritize external communication to build a community, not a user base.
- We iterate based on user feedback to solve problems better.
- We benchmark against the industry and our competitors to understand how we're doing and how to be better.
What are the costs of CFDs in Change?
Buying and selling CFDs in the Change app is commission-free. However, there are spread fees and overnight holding fees. Learn more on the CFD Pricing page.
What is the smallest amount I can start with?
You can start investing with as little as €10. This low minimum makes it easy for beginners to test CFD trading without committing a large amount of capital. Starting small also helps you practise managing leverage and understanding how price movements affect your positions before scaling up.
Can I specify the leverage for my trades?
The leverages are fixed based on the asset you wish to trade.
Are you planning to add new assets?
Yes, we are constantly evolving and adding new assets to invest in and trade with
