Are you interested in learning how to trade CFDs? Then read my guide, where I will explain to you how CFDs, aka contracts for difference, work and help you learn how to start CFD trading.
My step-by-step guide will run you through the process and highlight some of the risks associated with CFD trading. I hope this no-nonsense guide will teach you the ins and outs and show you how CFD trading works.
Also consider: My guide to the best CFD trading platform for beginners
How to trade CFDs in 7 easy steps
- Learn what CFDs are. Make sure you fully understand what CFDs are and their risks before you proceed.
- Choose a CFD Broker. If you’re unsure which one to choose, see my guide to the best CFD trading platform for beginners.
- Open a CFD account and add funds. You will need your national insurance number, personal ID and bank details. Fund your new trading account via a debit card or bank transfer.
- Choose a CFD market to trade in. Explore the various CFD markets available to you.
- Decide whether to buy or sell. Do as much research as possible before you take up a CFD position.
- Set your stops and limits. It is vital that you regularly review and adjust your stops and limits.
- Monitor and close your trade. When trading CFDs, you need to be actively keeping track of market conditions.
7 Steps to Trade CFDs
This seven-step guide is designed to help you trade CFDs with confidence. For that reason, my guide will also help you navigate the world of CFD brokers, highlight some of the principles of financial markets, emphasise the importance of implementing a risk management strategy, and explain exactly what a long or short position is. In essence, it gives you the tools needed to make CFD trades with confidence.
Step 1: What are CFDs?
Before you start, you may be asking yourself, “What are CFDs?” CFD is short for contract for difference. This is a financial derivative that allows traders to speculate on the price movements of various assets, such as stocks, indices, commodities, or currencies, without actually owning any of these assets.
CFDs offer flexibility due to their wide range of assets, coupled with their strong potential for returns regardless of actual market conditions. This has made CFDs a popular trading instrument, especially with active traders, thanks to their ability to take up very short-term positions, which is particularly useful with FX and commodities.
What makes CFD trading stand out from other offerings is the fact that you can trade on margin. This is a great asset for smaller traders, as it lets you open positions with only a fraction of the total contract value. This means that traders can gain exposure to larger positions with relatively small amounts.
That said, I should issue a caveat that, whilst leverage is a great tool for amplifying your profits, there are risks involved as well, and for this reason, you should ensure you have a risk management and trading strategy in place before you start trading.
Step 2: Choose a CFD Broker
In order to start trading CFDs, you will first need to open a CFD trading account. Usually, this will be with a CFD broker, but you may find that some market makers are also CFD providers.
One of the most important decisions you will make when trading, regardless of the product, is the choice of trading platform and finding the right broker for you and your needs. Sure, a quick Google search will throw up some results, but just because they are number one on a Google search does not mean they are the right fit for you.
Before you sign up with a broker and hand over your hard-earned cash, I strongly advise you to do some research or check out my review of the best CFD trading platforms in the UK. The legwork you do now will help set you up on a solid foundation for the long run.
Here are some key points to consider:
You should ensure that the broker is regulated by a competent financial authority; in the UK, this is the Financial Conduct Authority (FCA), and in the US, it’s the Securities and Exchange Commission (SEC). You should be able to check if a broker is regulated by checking the registry on the FCA website.
Look for brokers that have robust security measures in place to protect your personal and financial information; at the very least, they should be using encryption technology to keep your data safe. Also, make sure that your funds are kept in a segregated client account; a reputable broker will keep client funds separate from their own operational funds. That way, should the worst happen and a broker go bust, your funds, in theory, should be safe.
This is one of the most important criteria to consider, especially as a lot of the flashy “no fees” claims made by some brokers often hide a sting in the tail that ends up hurting your bottom line. Different brokers have various fee models, including spreads, commissions, overnight financing charges, trading fees, and withdrawal fees. Compare the costs across different brokers to ensure they align with your trading strategy and budget.
I highlighted some of the main points you should look into before making the plunge, but there are other things you should research. For example, I like to see what educational resources and tools the broker offers its customers. Sure, these resources may get overlooked by some, but in my opinion, a broker that offers useful tools and educational assets indicates to me that it cares about its customers. After all, knowledge is king, and by providing meaningful assets to its customers, a broker is helping its clients make better-informed decisions to trade CFDs online.
I would also recommend that you check out what account types they offer. Brokers offer a wide range of different accounts, which often come with a range of different features and benefits. Choose an account type that suits your trading style, capital, and experience level.
Lastly, be sure to compare several brokers based on these factors before making a decision. And if possible, why not open a demo account with your shortlisted brokers? A demo account is a great way to experience a CFD trading platform firsthand and determine which one best suits your preferences and trading style.
Step 3: Open a CFD account and add funds
So, let’s assume that, having read my above guide, you have settled on a broker that ticks all the boxes and is the best CFD trading platform for your needs.
Before you start, make sure you are on the official website of your chosen broker. It may sound obvious, but scammers are devious, and I recommend you check the website URL closely. If you have any doubts do a google search copying the website address this should help confirm if a website is legit or not
Once you are on the website, you will be asked to provide a range of personal information, including your details and financial information. This is completely normal. CFD brokers are required to comply with Know Your Customer (KYC) regulations, and for this reason, you will need to provide identification documents such as a passport or driver’s licence and proof of address, such as a utility bill or bank statement.
After you send off these documents, your broker will check them, and assuming all is well, they will verify your account. This can take just a couple of hours, but in some cases, it can take up to three days.
Lastly, assuming your account has been successfully verified and approved, you will need to add funds in order to start trading CFDs. Most brokers support a range of methods, such as bank transfers, credit or debit cards, or online payment systems. Decide on how you want to fund your broker account, and then simply follow the instructions provided by the broker to add funds to your account and start CFD trading.
Step 4: Choose a CFD market to trade in
Before you start trading, set out what your trading goals are and determine your objectives, be they capital growth, income generation, or simply hedging. Your goals will influence the markets you should focus on. Do you want to take up short-term or long-term positions? Understanding your goals, preferences, and strengths will help you narrow down your options.
Explore the various CFD markets available to you. You can trade contracts for difference in stocks, commodities (such as gold, oil, or natural gas), indices, forex CFDs, and even cryptocurrencies (like Bitcoin or Ethereum).
Each market has its own set of characteristics, including volatility, liquidity, and even trading hours (for example, foreign exchanges close on weekends). Consider the market’s performance, historical data, and any news or events that may impact it.
Step 5: Decide whether to buy or sell
If you want to learn how to trade CFDs successfully, then one of the most important decisions will be knowing when to buy or sell. The short answer is to check the market conditions, as CFDs will mimic the behaviour of the underlying market.
Put simply, if you think that the price of the underlying asset is due to rise, you should buy; conversely, if you feel markets will slip and prices are due to go down, then it’s time to sell.
Regardless of the market conditions, it is important to do as much research as possible before you take up a CFD position. Markets are ever-changing, and for this reason, you need to be proactive and try to stay one step ahead of the market in order to close your position and make a profit.
The agreement is based on the price difference between the entry and exit points, the buy price and sell price, of the underlying asset. Put simply, if you correctly predict the direction of the price movement, you make a profit. On the other hand, if prices move contrary to your analysis, then you make a loss.
Step 6: Set your stops and limits
Setting stops and limits is an essential part of risk management in CFD trading. Stops and limits are vital tools for helping you manage potential losses and lock in your profits.
Before you start trading contracts for difference, I recommend that you have strategies in place to help you trade. Starting with a stop-loss order. A stop-loss order automatically closes a trade in the event that the market moves against you. With a stop-loss order in place, you have an automatic “out” in place if markets move against your position.
When determining what your stops and limits are, you should consider your risk tolerance, trading strategy, and market conditions.
As I already mentioned, market conditions are always changing, and for this reason, it is vital that you regularly review and adjust your stops and limits. That way, you are able to effectively protect your capital from any unexpected market developments and potential losses when trading CFDs.
Step 7: Monitor and close your trade
When trading CFDs, you need to be actively keeping track of market conditions and making decisions based on your trading strategy.
In order to successfully monitor and close a deal when trading CFDs, I would advise you to set up a few simple measures that will keep you safe and help you beat the market odds.
Set up Price Alerts
Most trading platforms let you set up price alerts and send notifications for price movements. This way, you can anticipate a potential fall in the sell price or buy price and know in real time when a CFD trade price reaches certain thresholds.
Use Stop Loss and Take Profit Orders
Stop-loss orders and take-profit orders are incredibly useful tools that help minimise your exposure to leveraged trading and secure your profits on time.
In essence, a stop-loss order is an order placed with your broker to automatically close your trade if the price reaches a predetermined level.
A take-profit order works on the same principle but is used when the price of a particular asset reaches a level you are happy to sell at.
Most brokers and trading platforms offer these tools, and I strongly recommend you set them up, especially in the fast-paced world of CFD trading.
I’ve said it before, and I’ll say it again: knowledge is king. In any sector and with any product, make sure you are not relying on old news. You need to be continuously evaluating both the markets and the performance of your CFD trade.
If you have any doubts or concerns that the trade may no longer be a sure-shot, then it may be time to close the deal.
How to Trade a CFD: Example
I hope my guide has helped you understand the principles of CFD trading. But theory is no substitute for experience, so I hope the following CFD trading examples will help turn abstract theories into understandable realities.
Let’s assume, for the sake of my example, that current Tesco stock has a bid price of GBp 261.00 or GBp 261.50. This means I can buy Tesco at 261.50 and sell my stake at 261.00. Tesco’s margin requirement is 5%, meaning they will only have to set aside 5% of the position’s value as a margin.
Let’s assume I buy 1 Tesco CFD at GBp 261.50, and based on my analysis of the markets for that day and reading of reviews, I expect that it will close at GBp 280.00 later in the day. With CFD trading, you’re always offered two prices based on the value of the underlying instrument: the buy price (ask) and the sell price (bid).
Outcome 1: Tesco shares rise
My prediction was correct, and Tesco stock ended the day at GBP 280.00. Happy with my hunch, I closed my position (sell Tesco) and made a total profit of £18.50 as the sell price rose on the back of a stronger than expected performance.
Outcome 2: Tesco shares fall
In scenario B, let’s assume I didn’t do my research and misread the market, with Tesco announcing supply chain issues resulting in jittery traders selling their stock and markets closing at GBP 250.00. This means I will have made a loss of £11.50.
I hope the above example has clearly illustrated to you the fact that opening and closing trades successfully will depend entirely on your ability to read the market. When trading CFDs, you will soon see that positions can change literally in moments, and for this reason, you need to be prepared.
Also, if, after reading this guide to CFD trading, you have some further concerns about the CFD trade, it may be a good idea to seek guidance from a financial professional.
How to trade a CFD long or short?
You may have come across the terms “long” and “short”, I have mentioned them a few times in my guide already, and maybe you want to know what they mean and how to trade a CFD long or short.
Going long or short means you take a position on the CFD trade, either long (buy) or short (sell).
If you believe that a stock’s price will rise, go for a long trade. If you think it will fall, a short trade will let you profit from that price movement.
However, as I am sure you have noticed, the trade in CFDs is extremely fast-paced, as you are, in theory, trying to be a step ahead of movements in the financial markets. For this reason, I earlier highlighted the importance of setting up “stop loss” and “take profit” orders with your broker for each trade.
Assuming you know what your margins and leverage exposure limits are, you will want to place a trade with your broker.
This should be relatively easy to do; simply go to your broker’s trading platform, select the desired instrument, and input the trade details. Once you have input the relevant data, you should be able to see a “Buy”, or “Long”, button and also a “Sell”, or “Short”, button.
If you think the particular asset classes are going to rise, you will take a “long” position; conversely, if you think they will fall, you will take a “short” position.
As with any trade, make sure to monitor the trade so that you can make adjustments to your stop-loss and take-profit levels if necessary based on the evolving market situation.
What are the costs of CFD trading?
There is no simple answer to the question, “What are the costs of CFD trading?”
For this reason, I earlier advised you to thoroughly research your broker before taking the plunge and opening an account. Generally speaking, prices among brokers will be quite similar, but you should be aware that there are differences.
Some brokers may charge a commission on both sides of a trade, others on just the opening or closing position. Other brokers may have inactivity fees or charge you for access to market information and real-time data.
Also, you should remember that on top of the broker fees and other trading costs, you will also be required to pay capital gains tax on any profits you make.
Factoring in all these costs and the price differences between brokers may impact your overall trading strategy, and for this reason, it is important to factor in what your costs are likely to be before you start trading.