CFD trading allows you to trade markets like equities, forex, indices and commodities without having to buy and sell shares, currencies or futures. Instead you trade a contract known as a CFD, a form of derivative that offers several advantages over traditional trading.
A contract for difference is a type of derivative which works by acting as an agreement to exchange the difference in value of an asset between the point at which the contract is opened and when it is closed.
The price at which a CFD is trading will always match the current market price of its underlying asset. If you wish to buy a share CFD of Apple, for instance, then your CFD will increase in value as Apple’s share price increases. If Apple’s share price decreases then your CFD loses value accordingly.
However, there are several differences between trading a CFD and traditional trading. Two key differences are the ability to go long and short, and leverage.
You don’t have to use a CFD to mimic a standard trade – you can also open a CFD position that will increase in value as the underlying market decreases in price. This is referred to as selling or going short, as opposed to buying or going long.
If you think Apple shares are going to fall in price, for example, you could sell a share CFD in the company. You’ll still exchange the difference in price between when your position is opened and when it is closed, but will earn a profit if the shares drop in price and a loss if they increase in price.
With both long and short trades, profits and losses will be realised once the position is closed.
You can also use a CFD to get exposure to a much larger position than with a standard trade. Using leverage, you can agree to exchange the difference in price of a larger amount of an asset without having to commit to the full cost of the position at the outset.
Say you wanted to open a position equivalent to 500 Apple shares. With a standard trade, that would mean paying the full cost of the shares. With a CFD, you might have to only put up 5% of the cost.
You’ll still exchange the difference in price of 500 Apple shares from when your position is opened to when it is closed, so your profit and loss will still be calculated on the full size of your position. That means that profits can be hugely multiplied: but that your losses can as well, even above your original deposit.
Beyond the ability to go short and make use of leverage, there are several key reasons why traders use CFDs:
One key reason why many traders use CFDs is as a method of hedging against other open positions. If you own an asset in your portfolio that you believe may lose some of its value, CFDs can offset some of the potential loss by short selling.
For example, let's say you hold $1000 worth of BHP shares in your portfolio. If you short $1000 worth of BHP shares through a CFD trade, then should BHP’s share price fall in the underlying market, the loss in value of your share portfolio would be offset by a gain in your short CFD trade.
But there’s more to CFD trading than the CFDs themselves.
For a detailed look at the concepts behind a CFD trade, take a look at how CFD trading works.
There's no minimum balance to open an account, it takes less than five minutes, and there's no obligation to fund or trade.
1 Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the Australia.
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