Beginner Level

Learn basic topics about forex, platforms and trading.
If you are new to the markets, start here.

Lesson 2: What is CFD Trading?

A CFD is a contract for
difference. CFD trading allows you to take a position on the value of the
instrument without actually owning the underlying asset. One of the most unique
aspects of CFDs is that they allow you to benefit from both growing and rising
markets.

The term CFD stands for contracts
for difference
.

A CFD creates a contract between
two parties on the movement of an asset price.

There are several key features
of CFDs that make them a unique and exciting product:

  • CFDs are a derivative
    product
  • CFDs are leveraged
  • You can benefit and
    suffer losses from both rising and falling rates
  • We sell CFDs on more
    than 1000 global markets, including indices, bonds, currencies, commodities,
    and ETFs

CFDs are a Derivatives Product

This means that you don’t
actually own the underlying asset, just betting on whether the price goes up or
down.

Take stock trading as an
example. You would like to buy 10,000 shares in Barclays and its share price is
280p, which means that the total investment would cost you £ 28,000-not
counting commission or other charges that your broker would pay for the sale.
In return for this, you will obtain a stock certificate, a legal document that
certifies ownership of the shares. In other words, you have something tangible
to hold in your hands before you decide to sell it, preferably for money.

For CFDs, though, you don’t own
the stocks of Barclays. You’re only speculating and potentially profiting from
the same swings in share prices.

CFDs are Leveraged

This ensures that you achieve a
much larger market exposure for a relatively small initial deposit. In other
words, the return on investment is significantly higher than in other types of
trading.

Let’s get back to the Barclays
example. Those 10,000 shares in Barclays are 280p, costing you £ 28,000 and not
including any additional fees or commissions.

For CFD trading, however, you
only need a small percentage of the total trade value to open up your position
and retain the same level of exposure. Suppose that XTB gives you 5:1 (or 20
per cent) leverage on Barclays stocks, so you’d only need to invest an initial
£ 5,600 to trade the same sum.

If Barclays shares were raised
by 10% to 308p, the price of the role is now £ 30,800. Therefore, with an
initial deposit of only £ 5,600, this trade in CFD made a profit of £ 2,800.
That’s a 50% return on your savings, compared to a 10% return on the actual
purchase of the shares.

Nonetheless, the important thing
to remember about leverage is that while it can increase your gains, your
losses are also magnified in the same way. So if prices move against you, you
may be shut out of your position by a margin call, or you may need to top up
your funds to keep it open-so it’s important to understand how to handle your
risk.

If the shares of Barclays fall
by 10% to 252p, the place price is now £ 25,200. Therefore, with an initial
deposit of only £ 5,600, this exchange in the CFD amounted to a loss of £
2,800. That’s a-50 per cent gain on your savings, compared to a-10 per cent
loss on the direct purchasing of the stock.

What Markets can you Trade CFDs on?

We sell differential contracts
on more than 1500 global markets and various asset classes, all with the
ability to leverage and go both long and short, including:

  • FX
  • Indices
  • Shares
  • Crypto
  • Commodities

Profit from Both Rising and Falling Prices

If you think the asset price is
going to rise, you’ll go long or ‘buy’, and you’ll profit from any price
increase.

If you think that the value of
an asset is going to fall, you’ll go short or ‘sell’, and you’ll take profit from
every price drop. Of course, if markets don’t move in the direction you expect,
you’ll lose money.

Therefore, if you assume, for
instance, that Apple’s stock price is going to fall in value, you simply fall
short of Apple’s share of CFDs, and your profits are going to increase in line
with any price drop below your opening level. Nevertheless, if Apple’s share
price had actually risen, you would have suffered a loss for every price
increase. How much you profit and lose depends on the size of your position
(lot size) and the scale of your market price changes.

The opportunity to go long or
short along with the fact that CFDs are a leveraged product makes it one of the
most versatile and common ways to trade short-term movements in financial
markets today.