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The full and complete guide to CFD trading for beginners

CFD trading has become one of the most popular investment concepts in the past few months, with many investors starting to pursue it as a serious investment strategy.

In fact, a variety of brokers now offer CFD trading as part of their offering to their customers, as more and more people have turned to it to try and give their wealth a boost.

Of course, as with many trading strategies, it’s important to do your research first and confirm that CFDs are an appropriate choice for you before you put your money in the CFD market.

So, find out everything you need to know in my complete guide to CFD trading for beginners.

eToro

eToro

  • Extensive social trading network
  • Free demo account
  • Minimum deposit £50

67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money. Your capital is at risk. Other fees apply. For more information, visit etoro.com/trading/fees

Before you start CFD trading, please note: CFD trading is potentially lucrative, but these investments are also complex instruments that present a high risk to your money. In fact, more than half of retail investor accounts lose money when trading CFDs.

Please make sure that you know these risks before you start trading and that you’re aware there’s a high chance of losing money rapidly on your investment.

What are CFDs?

To begin with, it’s important to know what CFD trading is and how it differs from the more traditional investment options.

The term “CFD” stands for “contract for differences” and refers to an agreement between an investor and a broker to exchange the value of a financial instrument between the opening of a contract and the close.

This all sounds very complicated and technical, but it isn’t as scary as it sounds. Let’s break it down:

Traditional trading

First, it helps to understand how you might ordinarily approach a more traditional trade, such as buying stocks and shares.

Typically, when trading stocks and shares, you’ll purchase your investment in a particular financial market and then wait to see how the price moves.

So, for example, if you had £1,000 to invest, you might buy 100 shares at £10 each in company X, assuming there are no account or commission fees.

You can then potentially make money if the price of company X’s shares rises and you sell it. So, if the selling price rose to £15 each, you could sell your 100 shares for £1,500, netting you a £500 profit.

Of course, this also means you can lose money if it falls. If company X’s share price falls to £5, your shares would be worth just £500, a loss of £500 on your initial investment.

How CFDs work

By contrast, when you make a CFD trade, you don’t buy the underlying asset that you’re trading on. Instead, you make an agreement with your broker over the price movements of a financial instrument over a certain period.

In this example, rather than using your £1,000 to buy the 100 shares in company X, your broker asks for a percentage of the trade instead. This is known as the “margin”.

Let’s assume that a broker asks you for a margin of 5% of the trade. That means you pay just £50 to your broker.

If company X’s share price then rises to £15 as before, you’ll again make the £500 profit without having had to put your entire investing sum in the underlying market. All in all, this would be a successful trade.

But, if company X’s share price falls to £5, you’ll need to pay the broker the £500 difference. If you placed multiple losing trades like this, you can see how you could quickly lose money.

As you never own the underlying asset that you’re trading on, CFD trading is a type of leveraged trading.

Taking positions

The other key difference between more traditional investing and CFD trading is that you can make money from both rises and falls in the value of various investments across financial markets.

In general, unless you’re deliberately trying to “short” a stock, you’ll buy investments with the goal being to bag a profitable sell price if the value rises.

Meanwhile, with CFDs, you can trade on what’s called the “long” or “short” side.

Trading on the long side means that you’re putting your money in with the expectation that the sell price will rise.

By contrast, trading on the short side means that you’re expecting the sell price to fall, and so you’ve closed your position to cash in on a decrease in value.

It’s remarkably difficult to profit off falls in financial markets, and so the fact that trading CFDs can allow you to do this is one benefit of them as a product.

How do I trade CFDs?

It’s fairly straightforward to become a CFD trader, so all you need to do is follow these four steps:

1. Open an account

Firstly, you need to open an account with a CFD broker that offers CFD trades.

Some of the most popular platforms in the UK offer CFD trading, including eToro and IG.

2. Deposit funds

Next, deposit your funds into your trading account.

Make sure you don’t deposit money that you need for living your daily life and paying daily expenses, or more than you can afford to lose entirely.

3. Do your investment research

After you’ve decided how much to invest, you need to do your research into what kind of CFD investments you want to trade.

Whether that’s trying to analyse market patterns yourself or reading around CFD trading tips from other CFD traders, you’ll need to know what sort of investments to buy to create a successful strategy.

Use this research to inform your trading decisions.

4. Start trading

Finally, once you have money with a trading platform and you’ve decided on your investments, you can start making your trades.

As a beginner, it’s often sensible not to go overboard when you’re starting out. Take your time and be patient with your investments so that you don’t invest and lose all your money straight away.

Best CFD trading platforms

Not all brokers and investment platforms give you the ability to trade CFDs so you need to choose a CFD broker that allows you to do so using their trading account.

Fortunately, there are various available CFD brokers and platforms that UK investors can use. These brokers will have varying trading costs, including account and commission fees, so make sure you compare prices so that you find the right one for you.

You can read my list of the Best CFD Trading Platforms UK right here to find a CFD provider that suits your needs.

Is CFD trading good for beginners?

There are various pros and cons to CFD trading for beginners that will determine whether it’s a suitable choice for you.

Here are some of the advantages and disadvantages to consider if you’re thinking about using CFDs to make your trades.

Advantages

Market access

CFDs can help to give you access to different asset classes, investments, and financial markets than you might ordinarily be able to use when starting out.

Investing in different financial markets and assets like this can increase your ability to create a diversified portfolio.

Lower prices and fees

As well as easier access to a range of investments, CFDs allow you to trade expensive investments that you otherwise might not be able to.

For example, a company with a single stock price of £1,000 might be entirely unfeasible for you. But, by entering a CFD agreement with a lender, you might be able to access that same investment for a fraction of the actual buying price.

In turn, this also typically means you’ll pay less in fees, especially if these are calculated as a percentage of your investment.

This is particularly the case when using an execution-only service provider, which tend to be associated with lower fees.

Easy to execute

As much of the burden of the investment falls on the broker, CFD trades are straightforward and easy to execute for investors.

Long buying and short selling

Perhaps the biggest advantage of all for CFD trading is the ability to long buy or short sell.

Long buying has many similarities with traditional investing, targeting price rises in investments to achieve results.

Meanwhile, the fact that you can short sell CFDs to target falls in the value of investments gives you an additional way to target returns in your portfolio, especially in periods of market downturns.

Of course, as with long buying, you’re still exposed to the risk of a short sell backfiring and the price rising. In that case, you would have to pay the difference in the rise to your broker.

Disadvantages

Market risk

The biggest risk that CFDs present to investors is that they’re associated with a higher level of market risk and, subsequently, a greater chance of losing your money, especially during periods of market volatility.

Indeed, as CFDs are such complex instruments, all CFD brokers and platforms are now obligated to include a risk warning on their websites that includes the percentage of retail investors who have lost money trading CFDs through their platform.

This figure is nearly always above 50% and can climb as high as 80% on some sites.

This goes to show that CFD trading is inherent with risk. This can be particularly detrimental for beginners CFD trading, who may have less experience in navigating financial markets.

Leverage is a double-edged sword

The other big point to remember with CFDs is that leverage is somewhat of a double-edged sword. This is because, while making leveraged trades means you can make greater profits while putting down less money, by the same logic this means your losses are equally magnified.

This puts you at risk of losing significant sums of money, even if the initial amount you have to put down is relatively small.

Additionally, you’ll pay financing costs depending on how much money your broker has lent you. These costs can add up over time, potentially costing you more than the trades are worth.

Not a long-term strategy

When investing, many experts and professionals suggest a longer outlook when choosing investments, typically a minimum of five years.

However, as CFDs have a literal time limit that determines if you gain or lose money, this makes them entirely unsuitable as a long-term strategy.

So, if you wanted your investing to serve a particular purpose, such as helping you buy a home or build a pot towards your retirement, CFDs are unlikely to offer you what you’re looking for.

Demo account

If you want to learn how to trade CFDs but you’re concerned about losing money, some brokers and platforms offer a demo account where you can invest with virtual money.

You can then invest your virtual money in real investments so that you can see how prices and values would change in real time.

This can be a useful way to learn trading ideas and how CFDs work in practice, as you can visually see the numerical impact of your choices without having to risk any real money.

Trading in virtual currency can also be a good way to learn risk management with CFDs and further your trading education, finding where it’s possible to make money as well as learning how to identify a losing trade.

Heavy regulation

As a result of the risk it presents to investors, you may be unsurprised to find out that many governing financial bodies have taken steps to regulate and restrict trading.

While CFD trading is legal in the UK, the Financial Conduct Authority (FCA) published strict guidelines in 2019 to protect retail consumers.

These rules include instructions for firms such as:

  • Limiting leverage on CFD trades to between 30:1 and 2:1.
  • Closing a customer’s position on their behalf when their available funds fall to 50% of the necessary margin for maintaining their open CFD positions.
  • Providing protections to ensure that a client cannot lose more than the total funds in their CFD account.
  • Not offering monetary or non-monetary incentives to encourage trading. For example, a firm cannot offer you a sign-up bonus or a certain number of free trades if you make CFD trades on their platform.
  • Providing standardised risk warnings that tell customers how many of their clients using retail investor accounts lose money when CFD trading. These figures tend to be between 50% and 80%.

These rules apply to all firms operating in the UK.

In other major trading countries, the guidelines can be even harsher. In fact, the Securities and Exchange Commission (SEC) in the US has entirely restricted the trading of CFD contracts.

While it is fully legal and a viable option, this level of regulation is a reminder that CFD trading is potentially dangerous and could cost you a lot of money.

CFDs versus spread betting?

Often, new traders confuse CFDs with spread betting. And, while they are relatively similar, there are some key differences you should be aware of.

Spread betting involves placing bets on the future price movements of a particular investment, much like taking a long or short position with a CFD. But, unlike CFDs, a spread bet usually has a fixed expiration date for both your profits and your losses, depending on how that asset performs.

Spread betting can be associated with lower commission and transaction fees than CFDs. Profits generated from spread betting are also typically free from Capital Gains Tax (CGT) which CFDs are not.

However, spread betting still involves a great deal of risk, and so is only really suitable for investors with larger risk appetites. If you’re looking for strategies that are best for trading for beginners, spread betting may not be appropriate.

Should I trade CFDs?

All in all, figuring out whether CFD trading is right for you will come down to you as an individual and your personal circumstances.

If you can afford to take on extra risk in your investing, then CFDs can present a low-cost option for trading in assets that you might not be able to afford outright. You may also want to consider doing some investment research into different CFD trading strategies to hone your trading skills and make sure that you know how to buy and sell effectively.

Even so, it’s still often sensible to only include CFD trades as one part of a diversified investment portfolio. That way, your eggs aren’t all in one basket if your CFD trade doesn’t come off.

Taking financial advice

If you’re unsure whether CFDs are right for you, it may be sensible to seek independent advice from a financial advisor. An advisor will be able to give you personalised advice as to whether CFDs are appropriate for you based on your wider financial situation.

They’ll also be able to explain complex financial instruments and concepts to you in simple terms to help you make informed decisions with your money.

Crucially, as part of the service that they provide, a financial advisor can build you a financial plan that focuses your saving and investing on your life goals. This can be a transformative approach that helps you to see where your decisions are right for you, and where they may need to be refined a little bit further.

CFD trading for beginners: FAQs

How much money do you need to start CFD trading?

Some platforms allow you to start trading CFDs with as little as £10, which is part of the reason why it can make sense to consider CFD trading for beginners.

However, bear in mind that you’re unlikely to make much money from trading in such small amounts, particularly when you include account and trading fees in your calculation.

Is CFD trading profitable?

Yes, CFD trading is potentially profitable, providing that you do your research and make sensible, informed trades. However, there’s also a high risk of losing money when you trade CFDs. Upwards of half of all retail investors lose money when trading CFDs. CFD trading is done entirely at your own risk.

A note on CFD trading:

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

CFD trading is a high-risk investment strategy and is not suitable for all investors.

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