How does CFD trading work

Lesson 2 of 4

How a CFD trade works

Whenever you trade CFDs on something, you’re presented with two numbers: the buy price and the sell price.

So if you wanted to open a position on a commodity, let’s use silver as an example, you might see prices like this on your CFD platform:

Here silver is currently being listed by the provider at a spread of 1650/1653 (which is the equivalent of $16.50/$16.53 in the underlying market).

If you thought the price of silver was likely to rise, you could ‘buy’ at the higher price – also known as the offer price – of 1653.

Or if you expected the value of silver to fall, you could ‘sell’ at the lower price – known as the bid price – of 1650.

The gap between these two prices is called the spread.

What is the spread?

Neither the buy price nor the sell price represents the exact value of the financial asset you’re taking a position on (also known as the underlying asset). Instead, the buy price is slightly higher than this value, and the sell price is slightly lower.

In the above example, the real-world value of silver would be halfway between the two prices, at 1651.5. The difference between the buy and sell prices is 3.0 in this instance, which is a spread of three points.

How does the spread affect me?

The spread is essentially a fee that your CFD provider charges to place your trade, and the narrower the spread, the better it is for you. Let’s look at why.

To close a position, you need to take the opposite action to when you opened it. So if you open a trade by ‘buying’, you close by ‘selling’ and vice versa.

In our silver example above, if you ‘buy’ at 1650, you’ll need to ‘sell’ at the same price or higher when you close the deal, or you’ll make a loss. This means the underlying silver price will have to rise by three points before you break even.

So the size of the spread determines how far the market will have to move for your position to become profitable.

Deal sizes

CFDs are traded in standardised contracts, sometimes called lots. The sizes of these contracts differ depending on the asset, often mimicking how that asset is traded in the underlying markets.

Going back to silver, it’s traded in a contract size of 5000 troy ounces in the underlying market. For that reason, most CFD providers also offer silver in a contract size of 5000 troy ounces. This works out to be the equivalent of CHF 50 per point of movement.

Now that we know you can trade on a financial asset such as silver using CFD, let’s take a look at how you might go about taking a position.

Example: taking a CFD position on silver

Say you think the price of silver will rise, so you decide to ‘buy’ five CFD contracts at 1653.

A week later the price of silver is quoted by your provider at 1683/1686, and you think it’s time to ‘sell’ and close your position.

Your profit or loss is calculated as the number of contracts you’ve traded, multiplied by the value of the contract per point of movement, multiplied by the difference in points between the opening and closing prices.

So in the scenario above you would have made CHF 7500:

Five contracts x CHF 50 x 30 points = CHF 7500

You might also need to factor in commission or other charges, as we’ll explain shortly.

The number of contracts you choose to trade is up to you, but always remember that the value of one contract will vary from market to market and may be denominated in different currencies. For example, one contract of the FTSE might be worth CHF 10 per point of movement, while one Nikkei 225 contract might be worth just CHF 5 (or around CHF 3) per point.

When trading share CFDs, the contract size is usually equivalent to one share of the company you’re trading. So if you wanted to buy the equivalent of 1000 shares of Vodafone, you would simply buy 1000 Vodafone share CFDs.

CFD providers will offer information on the value of each type of CFD contract and the currency denomination. At IG, you can find this in our product details.

Question

Banking Company B is offered by a CFD provider at 565/567 - the equivalent of a bid price of CHF 5.65 and an offer price of CHF 5.67 in the underlying market.

You think the price of Banking Company B will rise, so you decide to 'buy' 10,000 shares as a CFD. Later that week Banking Company B is offered at 577/579. You decide to 'sell' and close your position. Ignoring any commission or other charges for now, how much profit or loss have you made?
  • a CHF 10 loss
  • b CHF 100 profit
  • c CHF 1000 profit
  • d CHF 100 loss
  • e CHF 10 profit

Correct

Incorrect

The price of Banking Company B rose by 10p per share between opening and closing, so you made 10,000 x 10p = CHF 1000. To calculate your net profit, you would need to deduct any other charges, like commission or overnight funding. We explain these below and in the next section.
Reveal answer

Lesson summary

  • When you trade CFDs, you're presented with a 'buy' price and a 'sell' price for each asset
  • The 'buy' price is the higher price, and is also known as the offer price
  • The 'sell' price is the lower price, and is also known as the bid price
  • The gap between the two prices is the spread
  • The spread is wrapped around the underlying market price and represents a fee for placing your trade
  • CFDs are traded in standardised contracts called lots, which differ in size for each asset
  • Profit/loss = number of contracts traded x value of the contract per point of movement x difference in points between opening and closing prices. (Note this is before any charges have been taken into account.)
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