What is CFD trading?

In this article you will be guided about:

What are CFDs? – Benefits and risks of trading CFDs.

What is leverage? - How to use it in practice.

What are CFDs?

CFD stands for Contract For Difference (contract for difference). As the name implies, this is a contract between two parties (often described as “buyer” and “sell side”) to an agreement on the price movement of an asset.

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Key features of contracts for difference that make CFDs a unique and exciting product:

CFD is a derivative commodity.

Traders can use leverage when trading CFDs.

You can profit and lose even if the price goes up or down.

Why call CFD a “derivative commodity”?

The term derivative goods means when CFD trading, you don't actually own that property. You are simply speculating whether the price will go up or down. When you trade CFDs, you agree to exchange the difference in the price of an asset from the moment a contract is opened, until it closes.

Stock Investment Example: You want to buy 10,000 shares of Barclays at a price of £2.8 per share. The total cost of your investment is £28,000 – excluding commissions or other fees the broker will charge for trading. You then receive a share certificate, the legal document confirming ownership of the shares. In other words, you have a set of validators in your hand until you decide to sell them, in the best case for profit.

With CFDs, however, you don't own those Barclays shares. You are simply speculating and potentially profiting from similar movements in stock prices.

What is leverage in CFD trading?

Lever means you are allowed trade in large volumes with a very small corresponding initial capital. In other words, your return on investment is significantly greater than with other forms of trading.

Back to the Barclays example: those 10,000 Barclays shares cost £2.8 per share, costing you £28,000 and not including any additional fees or commissions.

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However, with CFD trading, you only need a small percentage of the total capital of the trade to place an order and maintain its position. Assuming XTB gives you 1:5 (or 20%) leverage on Barclays stock, then you only need to deposit a capital (margin) of £5,600 to open a position for a trading volume of £28,000.

If Barclays share price increases by 10%, to £3.08 per share, the value of the order is now £30,800. So with an initial deposit of just £5,600, this CFD trade made a profit of £2,800. That's a 50% return on your capital. If you buy the actual stock the rate of return is only 10%.

However, it is important to remember about leverage that this tool can not only amplify your profits, but also multiply your losses in a similar way. So, if the price moves against your prediction, you may be forced to close the order (Stop Out) or have to deposit more money to keep the order open. This is why risk management is so important.

If Barclays shares fell 10% to £2.52 per share, the value of the order would now be £25,200. So with an initial deposit of just £5,600, this trade lost £2,800. That's a -50% loss of your capital, if buying the actual stock it's only a -10% loss.

What is Margin CFD Trading?

Margin trading is simply another term to describe leveraged tradingbecause the amount required to open and maintain a leveraged position is called 'margin'.

Types of CFD contracts that XTB offers

XTB offers contracts for difference (CFDs) of more than 4000 tradable tokens globally. All have leverage and can open both Buy and Sell orders. Consists of:

Forex

Index

Currency

Goods

How does CFD trading work?

Now that you know what a CFD is, let's take a closer look at how CFD trading works. To understand how CFD trading works, you need to master the following concepts and how to apply them in CFD trading:

Spreads and commissions

Trading volume

Transaction duration

Spreads and commissions

A CFD contract is quoted at two prices: purchase price and price and allows you to profit from both scenarios: rising price and falling price.

If you believe that the price of a product will increaseyou will Buy (Buy) and you will make a profit from each price increase.

If you believe that the price of a product will reducedyou will order to sell (Sell) and you will make profit from each discount.

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Of course, if the market doesn't move in the direction you expect, you will lose money.

For example, if you believe that Apple's stock price will fall, you can simply place an order to sell Apple stock and you will profit when the market price falls below your opening level. However, if Apple's stock price rises, you will suffer a loss. How much profit or loss will depend on your open volume (lot) and the size of the market volatility.

The ability to open both buy and sell orders, along with the use of leverage when trading, makes CFDs one of the popular choices for short-term trading in today's financial markets.

Trading volume (lot)

CFDs are actually traded in standard sized contracts, aka lots. The volume of a lot depends on the traded product. The lot usually simulates the basic accounts in the market.

Transaction duration

Normally, CFD trading does not have fixed term. Trading orders can be simply closed on your trading platform.

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