Trading contract for difference (CFD) is a popular and one of the most sought out investments in the UK. As a beginner, you should understand what trading CFD is all about before you pull the trigger. Since your search has led you here, you might as well get comfortable because this guide will let you in on all you need to know about CFD trading.
We believe that once you are done reading this guide, not only will you understand what CFD trading is, but you will also have the concepts of the essential terms used when trading CFDs. This will get you in the right space to begin this business venture.
What is CFD trading
While some of you might understand what contracts for difference (CFD) trading is, let’s jog our memories a little, or better still, get the novice traders on the same page. CFD trading is a way a trader speculates the fluctuating financial markets without taking any underlying asset’s ownership.
CFDs are very popular derivatives in the financial markets, and they track the movements of the assets. Usually, the parties involved are the buyer and a seller whose main objective is to profit when the fluctuating markets favour them. The broker only acts as a middleman and sets the CFD assets’ prices depending on the market trends.
Simply put, the buyer’s goal is to gain profits if the asset’s price at the end of the derivative trading is higher than the buying price. On the other hand, the seller also hopes to bag some profits if the CFDs asset selling price is higher than the price at the end of the derivative trading.
What is Contracts for Difference (CFD)
Contracts for difference, commonly known as CFD, is a contractual agreement in a derivative asset class between two parties. With CFDs, you will not own an asset but simply speculate on its movements.
Note that with CFD, both parties involved agree on exchanging an asset’s difference in value between the beginning and the end of the derivative contract. The significant assets to trade CFDs are forex, shares, commodities, and indices.
How CFD trading works
If you do not want to trade the traditional way of buying and owning an asset, CFD trading is a perfect alternative. It is very flexible in that you only get to focus on how to strategise for the win.
You will always need a broker to trade CFDs. This is because brokers know how to manage the market demand and supply, thereby setting reasonable prices. Whereas two parties are involved in CFD trading, brokers act as intermediaries.
Traders can either go long or go short with CFD trading. Going long means that you open a buy position on an asset after speculating that its price will increase. This means that the more the prices keep going up, the more profits you gain.
When it comes to going short, traders open a sell position on a particular asset after speculating the fall of the asset’s price. Here, you only want the prices to keep dropping to earn that cash.
How do you trade CFDs
Getting started with CFD trading is very straightforward, and there is no right time to start trading. Although many may recommend this form of trading to expert traders, we encourage beginners also to give it a shot. After all, how can you become an experienced CFD trader without trying right?
- Identify a CFD broker
As a novice trader, you most probably have zero experience trading CFDs. Therefore, you need a good broker that will let you learn to trade before you begin to invest your funds.
Long before trading rules were improvised, traders used to spend money on demo accounts. Most traders were skeptical because of the fear of losing their money before creating a live trading account.
Since paid demos are no longer in existence, brokers have experienced tremendous response from traders, which has led to CFD trading being among the most popular forms of trading.
Note that finding a broker is a very important part of your trading career. The broker must compliment your trading style, strategy, and experience, so you need an extra eye for detail here.
Many traders fall short in finding a suitable broker, which affects their entire CFD trading activities. Do not fret, though, because TradingGuide.co.uk simplifies everything for you.
On this website, you will find the necessary tools to get you started as a CFD trader. Its main objective is to educate traders on safe trading and recommending the best UK brokers that its experts have tested and proved to be worth considering.
For more information about what we do, kindly visit the About Us page.
- Understand the basics of CFD trading
To successfully trade CFDs, you need to have a better understanding of the tools you need while trading. CFD trading is a contract derivative form of trading, which means it has an expiry period. Because of this, you need to be very careful when venturing into CFD trading.
That being said, below are the essential elements that you need to be aware of before venturing into CFD trading.
Every broker will have its own specifications, so you need to study and choose the ones that work best for you. These specifications can include the number of CFDs, stop-out level, trading fees or commissions, leverage, and more.
This involves studying the financial market factors that cause the fluctuating prices of the underlying financial assets. You will analyse economic and financial factors from significant events or companies to measure the assets’ value.
Here, you will study the financial markets’ behaviour using graphic tools, reports, and indicators. With these tools, you will also predict how an asset’s price will trend in the long run.
You probably must have heard that CFDs are products of leverage. This means that with leverage trading, a broker will loan you funds to trade with, which of course, you will refund with interest.
The advantage of leverage is that you increase your potential of earning more profits. Note that Europe has stringent regulations on leverage trading. You are limited to maximum leverage of 20:1 for major currency pairs and 10:1 for major stocks and commodities.
Note: Leverage trading is highly risky. Therefore, before venturing into it, make sure you understand how it works and has conducted thorough research and analysis on the instruments you wish to trade.
- Pick a strategy
CFD trading strategies require complete focus, dedication, and time to speculate the fluctuating markets and try to outperform them. Stay abreast with the latest financial markets’ trends so that you will stay on top of your business investment.
With CFD trading, most expert traders prefer developing their own strategies. Therefore, we encourage you to emulate them and start doing the same when you are confident with your skills.
Since you can only trade CFD as a buyer or seller, choosing the best strategy will greatly impact your activities. Trading CFD is done chiefly using intra-day, day trading, swing trading, leverage trading, or scalping strategies that will not incur financing costs for overnight positions. Let’s dive a little deep into these CFD trading methods.
With intra-trading, you will be able to trade CFDs within a short period, usually within seconds, minutes, or hours. It is a type of trading that must be completed within the set time frame.
The main objective of trading CFDs with this type of trading is that it allows you to take advantage of the rapid price movements and see if you can earn some profits. It is a form of trading that can be profitable if you are keen on observing the markets.
The profits you earn using this strategy are small, meaning you need to trade repeatedly to make a substantial amount. Intra-day CFD trading is best suited for futures products like crude oil.
Since day trading involves placing multiple trades within a day, most traders believe that it is a costly investment. However, with the proper budget and plan, day trading can be affordable to any CFD trader in the UK.
Like the name says, day trading involves opening and closing positions within the same day. The typical markets for CFD day trading are forex and stocks, which have been profitable to CFD traders who have mastered the techniques.
There are various processes involved in day trading CFDs, and you need to have the necessary knowledge to succeed. This means that some traders fail to succeed in day trading because of impatience and not staying consistent.
Swing trading also involves speculating on price movements of CFD assets within a day. What makes it different from day trading is that a trader can open a position for a more extended period, usually days or weeks.
Swing trading allows you to maximise your earnings. It is known to be easier to master than day trading. Therefore, as a beginner, it is a safe choice.
Leverage or better known as margin trading, is another common strategy for trading CFD. With leverage, your broker loans you trading funds that you have to refund with interest.
It increases your exposure and chances of earning more profits. Remember, since it gives you a great potential to gain more profits, your margin for loss is also high. Simply put, when you succeed, you earn big, and when you lose, you fall tremendously.
Europe, which includes the UK, has stringent rules on leverage mainly because of the risks this strategy carries. Since the major trading CFD assets are stocks and forex, the leverage limit has been capped at 20:1 for CFD forex trading and 10:1 for CFD stocks.
The current regulations of leverage trading do not support negative balance protection. So, when trading leverage, keep in mind that you are not protected from losing more than you own.
Like intra-trading, you take small profits with scalping. You get to speculate on small fluctuating prices within seconds or minutes. It is a challenging strategy to master if you are not patient and consistent with your CFD trading activities.
The best thing about scalping is that you can enter and exit the financial markets quickly. However, with this strategy, you need to be alert at all times and have a stable internet that will not inconvenience your activities.
Additionally, choose a reliable broker with adequate features such as Direct Market Access (DMA), which lets you take control of your activities.
- Start trading
Once you have figured out your best strategy, you can now open a position and try your luck in CFD trading in your preferred market assets. Most of the regulated brokers will support you with the trading tools you need, whether for market analysis or managing the risks.
There are traders' guides and educational materials on most UK CFD brokers for newbies to get started with, especially on our recommended ones. The educational materials include recorded videos, live webinars, articles, and even demo accounts that you can use to get familiar with CFD trading free of charge before making any serious moves.
Some UK brokers also feature the copy trading feature on CFD trading, which can boost your skills and chances of making profits. This feature works by letting you follow expert traders, and whenever they open a position with potential profits, you can copy from them.
To effectively differentiate which position is likely to earn you profits, you still need to be knowledgeable and strategic. That is why with this guide, you will learn the basics of CFD trading and be prepared to enter the CFD trading industry with confidence.
Note that your first trade might be profitable or cost you some money. This doesn’t mean that you should pump the brakes. Or rather, take it as a learning experience because even the most professional traders have their rainy days.
Factors to consider before trading CFDs
Before getting started with CFD trading, you should know how to choose the right CFD app or platform. On our TradingGuide.co.uk website, you will find our recommended brokers and the CFD categories that they are best suited for. We advise you to compare them and pick the one that ticks all the boxes in your requirements list.
Additionally, below are the other factors you must consider after choosing your best CFD broker.
The first question you need to ask yourself is if you can trust the CFD broker of your choice with your trading funds. How protected are you, and is its trading platform transparent? To ensure your security, the broker must be regulated by at least one renowned financial authority.
Remember, the good thing about regulated CFD brokers is that you can easily report them to the responsible regulator if you feel that they are not safe and offer a transparent environment for you.
In case you do not know how to confirm a CFD broker’s credibility in the UK, you can visit the Financial Conduct Authority’s website and see if it is among the list of regulated brokers.
- CFD analysis tools
Your broker should connect you to adequate CFD trading tools. For example, tools like the Commitment of Traders (CoT) reports and quality news feeds should be at your disposal since they keep you abreast with the latest financial market trends.
- Margin requirements
Knowing your margin requirements before getting started with CFD trading is essential, especially if you plan to trade on leverage. Remember, the leverage rules in Europe vary with instruments that you wish to trade.
For example, the application of leverage on CFD forex trading is capped at a maximum of 20:1. This means that you can trade with as much as £20,000 for an account balance of £1,000.
Although this margin looks attractive, note that higher leverage carries greater risks. The more you leverage, the higher your profit potential and the magnitude of your loss. So, remember this before you apply any leverage.
As a newbie, conducting the necessary due diligence on a broker is very important. The fees a broker charges for CFD trading should not inconvenience your budget. Note that CFD brokers have varying fees for trading, whether it’s minimum deposit requirement, transaction costs, commissions, spreads, market data fees, or overnight charges.
With a broker within your budget, it is easy to trade CFD assets of your choice and try out other assets if you wish to explore other options.
How to manage CFD trading risks
Many traders profess that CFD is a risky investment. However, how do they manage those risks to the extent that they end up trading CFDs successfully? Let’s find out.
Getting started with a supportive and regulated broker is one step to managing CFD trading risks because your funds are secure. With such brokers, you also get negative balance protection, tight spreads, and essential CFD trading risk management tools to limit losses.
Below is how you can use such tools to manage CFD trading risks:
Market volatility can significantly affect your predictions. If this happens when you have placed a stop-loss order, your open position will automatically close when it reaches a specific price point.
You can limit your orders by setting the profit level at which your position should close. This feature will apply irrespective of whether the market prices keep rising or dropping. It is one of the best ways to trade CFD safely, but know that your order can also go below the specified profit level, which can bring you losses.
With a trailing stop-loss order, you can shift your profitable position to a maximum value or set a percentage of loss. If your security’s price rises or falls favouring your activity, the stop price rises with it. However, in case the fluctuating prices do not favour you, then the stop price remains intact.
With guaranteed stop-loss orders, you are assured that your positions will close when they reach the specified level. This stop-loss order will take effect regardless of the fluctuating markets or even when you are not around to manage your activities.
Pros and cons of CFD trading
CFD trading can benefit you in many ways, and it also has its drawbacks. Let’s look into more details about the benefits and risks.
- With the rising and falling prices of CFD assets in the financial markets, you can make profits trading CFDs depending on whether you are going long or short.
- CFD trading comes with high leverage and can benefit a trader if they know when to apply it. Although leverage is a double-edged sword and carries high risks of profits and losses, it can earn you good profits if you adhere to the broker’s rules.
- Trading CFDs nowadays does not limit your market access. Whether you want to trade CFD on forex, stocks, or commodities, you just need to find a broker that allows what interests you.
- When you speculate a declining price in the coming days, CFD trading gives you an option to short sell the assets and earn profits from the difference between the selling and buying price.
- CFD trading platforms mostly charge lower fees or commissions, which can allow you to open multiple positions daily.
- The high leverage can cost you a considerable amount of your investment funds.
- Most CFD brokers will charge you financing costs on CFD leveraged positions that are left overnight.
- Since CFD trading is only about speculating on financial assets’ prices, you will never physically own shares or commodities when you trade CFDs.
You most certainly must have heard that trading CFDs is more challenging than trading other assets. This information could get you thinking that maybe CFD trading is not something you can profit from.
To put any doubts to rest, all tradable instruments, including CFDs, carry risks. Therefore expert and novice traders alike should have a few strategies up their sleeves to increase their probability of making profits.
Additionally, you have to be knowledgeable about every detail involved in CFD trading. At TradingGuide.co.uk, you will access reliable information and recommended brokers that will set you on the right path to success.