CFDs, or contracts for difference, are derivative instruments used by traders to places bets on all types of securities without actually holding the underlying assets. Trading of this type originated in London, but CFDs have taken off in popularity thanks to minimal fees and terrific margin percentages. CFDs are also highly speculative and banned in a number of countries, including the United States.
How to Start Trading CFDs
Getting started on CFDs is just as easy as opening a traditional brokerage account. Just find a broker that fits you and fund your account. Remember, CFD trading is banned in the United States, so no American regulatory authority allows this market.
Most CFD brokers follow the rules and are regulated by some international body, but some offer very little oversight. Make sure your broker is legit before signing up! Between 70 to 80% of retail investors lose money trading CFDs. Check the websites of the brokers listed below — they’ll flat-out tell you most people lose money trading CFDs. Be aware of the risks before you open an account.
Step 1: Find a broker that offers CFDs
You won’t find a regulated U.S.-based broker to trade CFDs since they’re banned in the U.S., but international traders still have plenty of brokerage choices. Before you choose a broker, make sure it’s regulated by the Financial Conduct Authority (FCA), European Securities and Markets Authority (ESMA) or another government entity. Some of the most popular (and well-regulated) CFD brokers are:
- Best ForMarket-leading SpreadsOverall RatingRead Review
79.17% 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.
Step 2: Find an instrument you want to trade
Once you’ve found a broker that fits your needs, it’s time to make that first trade. Go through your broker’s selections and choose the type of market you want to bet on. Here’s what you’ll find available at most CFD providers:
- European stocks/indices
- U.S. stocks and indices
Pay attention to the spreads here, especially in a no-commission account. Commodity and forex trades are usually done on the thesis of economic and political uncertainty, while stock and index CFDs are done on a micro level. Pick a market and select your instrument to trade.
Step 3: Fund your account and execute your trade
Once you’ve decided what type of CFD to buy, fund your account and decide how much capital you want to put into the trade. Remember, CFD brokers usually give you margin rates around 2-3%, compared to 50% with traditional brokers.
Only a small amount of money is needed to record big wins in the CFD market, but beware the hazards of CFD trading. If business is done with an unscrupulous broker, you might be out of money even if you’re on the right side of the trade.
What are CFDs?
A contract for difference is simply a financial agreement between two parties, one deemed the buyer and one deemed the seller. CFDs are written for a number of different bets on financial products, including stocks, indexes, currencies and commodities.
Sellers of CFDs expect the underlying asset to decline in price, while the buyer expects the price to increase. Let’s say a CFD is drawn up over PayPal shares, currently priced at $94.91 per share. If the price has increased to $96.97 by the end of the contract term, the seller must pay the buyer $2.06 per unit. In the stock market, 100 PayPal shares in a traditional brokerage account equate to a $206 gain on a $9,491 initial investment.
That’s a measly 2% return (4% if trading on margin) and commissions haven’t been factored in yet! However, CFD traders buy their investment on 5% margin. Instead of $9,491, only $474.55 is needed to get that $206 gain. That’s a 43% gain (give or take the cost of the spread) and no commission is due.
Opportunities like these make it easy to see why CFDs are popular, but leverage works both ways and inexperienced traders could easily lose more than they deposit.
CFDs are legal to trade in most of Europe, as well as Canada, Australia, Israel, Japan, Turkey, Russia, Singapore, Chile and South Africa. CFDs are not legal to trade in the United States, India, Brazil, Belgium and Hong Kong.
Why Trade CFDs?
CFDs have a few advantages over the financial products offered by traditional online brokerages:
- They offer high leverage. Most stockbrokers require 50% margin to trade with leverage. CFD providers require far less, often as low as 5%.
- There are low (or no) commissions. The spread is usually the only “fee” when making a CFD trade. Even if the CFD brokerage charges commission, it is far lower than commissions offered by traditional brokerages.
- There are no day trading limits. In the United States, active traders who buy and sell the same stock in the same day can only make three such trades before being labeled as a pattern day trader. To get around this rule, a trader must have $25,000 in his account. No such rules exist on the CFD market.
- There are no rules against shorting. In some markets, shorting a stock might be illegal or unallowed, which means stock options are the only way to bet on share price declines. CFDs have no rules against shorting and traders are free to bet against any financial product that can be contracted.
CFDs have a number of benefits over traditional stocks, but leverage of this magnitude isn’t for everyone. The CFD market is highly volatile and unregulated, so inexperienced traders could lose more than their initial investment if they aren’t careful.
Final Thoughts on CFDs
CFDs are currently banned from the United States, although reception appears to be warming up to them. Instruments like these are highly volatile and reputable CFD brokers admit that most of their clients do lose money. If you still want to travel down this road, take a look at the brokers listed above. You’ll likely find exactly what you’re looking for.
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