CFD Trading Guide
- Written By thinkforexbrokers
- Updated:
Online Contract for Difference (CFD) trading has grown significantly over the past twenty years. CFDs offer an alternative to traditional markets by allowing investors to speculate on price movements without owning the underlying asset. A key feature of CFDs is leverage, which can amplify both potential profits and losses, making careful risk management essential. While CFD trading carries inherent risks, it also provides opportunities for gains when approached with knowledge and discipline.
This guide will explain what CFDs are and how they function, covering their costs, advantages, and disadvantages. We will also explore the principles of margin and leverage trading. To conclude, a simple CFD trading strategy based on technical analysis will be provided to help you navigate these complex instruments effectively.
What is a Contract for Difference (CFD) and how does it work?
A Contract for Difference (CFD) is essentially an agreement between a CFD broker and a trader to exchange the difference in the value of a specific trading instrument—such as a commodity, stock, stock index, or cryptocurrency—between the opening and closing of the contract. Unlike owning the underlying asset, the CFD’s value depends solely on the price change between your entry and exit points.
CFDs allow traders to profit from price movements without taking ownership of the underlying asset. For example, instead of physically buying and selling barrels of crude oil, you can simply speculate on whether its price will rise or fall.
A CFD trade involves two transactions: opening a position and later closing it with a reverse trade through the broker. If your initial trade is a long position (buy), the closing trade will be a short position (sell), and vice versa. Your profit or loss is determined by the price difference between the two trades.
Traders use CFDs to speculate on market directions. If you anticipate that an asset’s price will increase, you open a CFD buy position and later sell it to realize gains. Conversely, if you expect the price to drop, you can open a CFD sell position. The resulting profit or loss is calculated as the net difference between the opening and closing prices and is settled through your trading account with the CFD broker.
What are the costs of CFD trading?
When you trade CFDs, you will incur the following costs:
Type of cost | Explanation |
Spread | The spread is the cost built into the price of the instrument you trade. It is the difference between the bid price and the ask price. Brokerages have begun to offer tighter spreads on CFDs due to intense competition in the industry. |
Commission | A flat fee paid per position, often used as an alternative to charging via the spread. When trading Forex pairs on a Standard Account, you will not be charged any commissions. However, ECN Accounts will charge a small commission per Standard Lot (100,000 units) traded. There will also be no commissions charged on Commodity CFDs, Stock Index CFDs, and Crypto CFDs. When trading Stock CFDs, you will be charged commissions for both opening and closing of positions. Those charges will vary depending on the exchange where the Shares are listed. |
Overnight Financing Charge | The cost of holding a position active overnight. There will be a charge on each day you hold the position. The charge will depend on the trading instrument and the direction of the trade (long or short). |
Suppose you decide to buy CFDs on Barclays PLC stock, currently priced at GBP 185 per share, expecting it to rise to GBP 210. You purchase 110 CFD contracts, giving a position size of GBP 20,350. When the stock reaches GBP 210 in 15 days, the gross profit would be GBP 2,750. However, you must account for trading costs: a 0.1% commission on opening (GBP 20.35) and closing (GBP 23.10) the trade, plus an overnight financing charge of 7.5% annually, which over 15 days amounts to GBP 62.70. After deducting these charges from the gross profit, your net profit comes to GBP 2,643.85. This example illustrates how commissions and financing costs reduce overall returns, emphasizing the importance of considering all associated expenses when trading leveraged CFDs.
In which jurisdictions can you trade CFDs?
CFDs are permitted in many major economies, including Germany, the UK, France, Switzerland, Canada, Singapore, Spain, Italy, Hong Kong, Australia, New Zealand, Thailand, Sweden, Norway, Denmark, and the Netherlands. However, jurisdictions like the EU, UK, and Australia have imposed leverage restrictions on CFD products offered to retail clients (see the “leverage” section for details). In 2021, the UK’s FCA also restricted cryptocurrency CFD trading for retail traders due to the high volatility and risks associated with this asset class. Conversely, CFD trading is prohibited in the United States because CFDs are over-the-counter instruments not traded on regulated exchanges, and leverage can lead to significant capital losses. CFDs are also banned in Belgium, Hong Kong, and Brazil, though residents of Hong Kong and Brazil can still access CFDs through overseas brokerages.
What are the benefits of CFD trading?
CFDs offer several distinct advantages compared to traditional trading. Firstly, they allow the use of higher leverage ratios, which vary depending on the financial asset and jurisdiction. While leverage of 1:100 or more was previously common, regulators in some areas have now imposed strict restrictions to protect retail investors. Higher leverage reduces the capital required to open a position and can amplify potential returns, but it also increases the risk of significant losses. Secondly, CFDs provide access to global financial markets through a single platform, with most brokers offering 24-hour trading across major markets worldwide. Thirdly, CFD brokers typically provide a wide range of order types—such as Stop orders, Trailing Stop orders, Limit orders, and contingent orders like “One Cancels the Other”—often free of charge, with Guaranteed Stop orders available for a small fee or wider spread. Spreads and occasional commissions vary based on the volatility of the instrument, with some brokers offering fixed spreads for certain assets. Fourth, CFDs eliminate shorting restrictions present in traditional markets, allowing traders to sell derivatives at any time without borrowing costs. Fifth, there are no day trading requirements, minimum trade restrictions, or limitations on trade frequency in CFD trading; most brokers require only modest deposits, typically between $100 and $500 for a standard account. Finally, CFDs offer a wide variety of tradable markets, including Forex, Cryptocurrencies, Commodities, Stock Indices, Stocks, ETFs, and Bonds, giving speculators broad options to trade across multiple asset classes without the constraints of strictly regulated exchanges.
What are the drawbacks of CFD trading?
Trading CFDs comes with several disadvantages that traders should carefully consider. First, every CFD trade requires paying the bid-ask spread when opening and closing a position. This reduces the potential to profit from small price movements, slightly lowering gains on successful trades and slightly increasing losses on unsuccessful ones. Second, CFD trading carries various risks, including market volatility, leverage amplification, and the possibility of losing more than the initial investment. Third, the regulatory oversight of the CFD industry remains limited. The credibility of a CFD broker depends largely on its reputation, business track record, and financial stability rather than government regulation or mandatory liquidity requirements. Therefore, thorough research on a broker’s reliability and operational history is essential before opening a live trading account.
Type of risk | Explanation |
Counterparty risk | When you purchase or sell a CFD, the only asset that is being traded is the contract the CFD broker issues. Thus, you will be exposed to the CFD broker’s other counterparties (including clients the broker does business with). There is a risk that the counterparty does not manage to meet its financial obligations. In case the CFD provider defaults on its contractual obligation, then the value of the CFD contract becomes irrelevant. Profound research on the brokerage you intend to open an account with is highly recommended. |
Market risk | In reality, no one can be 100% correct in their predictions of market movements. Sometimes, unexpected changes in market conditions, macro data, or government policy can lead to quick changes in prices. Because of the sheer nature of derivatives such as CFDs, small changes may have a huge effect on traders’ returns. If there is an unfavorable impact on the price of the underlying asset, the CFD broker may require an additional margin payment. If you fail to meet a margin call, the CFD broker may close your position, or you may need to sell at a loss. |
Client money risk | In jurisdictions where CFD trading is permitted, client money protection legislation is in place to safeguard investors against potential fraudulent behavior by CFD brokers. All client money transferred to a CFD brokerage is required to be kept fully segregated from that company’s funds. This way, the CFD broker will not be able to hedge its own investments. Still, the legislation may not necessarily ban client money pooling into one or more accounts. At the moment a CFD contract is agreed upon, the broker will withdraw an initial margin from the pooled account and it may also request additional margins. Note that in case some of the other clients in the pool do not manage to meet margin calls, the CFD broker has the right to withdraw from the pooled account. This could potentially affect traders’ returns. (We discuss margins and margin calls in detail in the following section of the guide.) |
Liquidity risk | Market conditions affect a huge number of financial transactions. At times, there could be not enough trades in the market for a particular instrument and, as a result, your existing CFD contract could turn out to be illiquid. In such a case, your CFD broker may require extra margin payments, or close the contract at unfavorable prices. |
Leverage risk | Potential losses are amplified along with profits. Traditional Stop-Loss orders available with the majority of CFD brokerages will not guarantee you won’t incur losses – especially in the event of market closure, or during sudden price moves. Some brokers offer additional risk management tools such as Guaranteed Stop Loss orders, but at an extra cost. |
Execution risk | You should be aware that negative slippage may occur at any time (your position may close at a worse price level than anticipated due to latency or other factors). Reputable CFD brokers will usually disclose their execution statistics. |
Let’s illustrate with an example: Boeing Co. shares have an ask price of $180.75, and you plan to buy 50 shares. The total transaction cost, including commissions and fees, is $9,037.50. A traditional broker typically requires a 50% margin, meaning you need at least $4,518.75 in free cash. In contrast, a CFD broker may only require a 5% margin, or $451.88. Keep in mind that a loss on a CFD position initially equals the spread at the moment of the trade. For instance, if the spread is $0.10, the stock must move $0.10 in your favor to break even. Owning the stock outright would also involve paying commissions, resulting in a higher capital outlay.
If the stock rises to a bid price of $182.00, a traditional brokerage sale would yield a profit of $62.50, or 1.38% ($62.50 ÷ $4,518.75 × 100%). Meanwhile, the CFD bid price may be $181.75, meaning your CFD profit would be $50. Despite this smaller absolute profit, the return on your invested margin is significantly higher at 11.06% ($50 ÷ $451.88 × 100%). Note that CFDs might require buying at a slightly higher ask price, such as $181.00, but the $50 gain represents a net profit, whereas the $62.50 from owning the stock outright does not account for commissions or other fees. This example demonstrates how CFDs allow a smaller capital outlay and can generate a larger net return relative to the invested margin. Next, we will explore margin and leverage in more detail.
What does the term “margin” mean?
Trading CFDs on margin lets you use leverage across various financial instruments, including Stock Indices, Forex, Cryptocurrencies, Commodities, Stocks, and ETFs. This approach allows you to open larger positions while depositing only a small portion of the total trade value. The required deposit is known as the “margin requirement,” which represents the percentage of the full trade value that must be available in your account to enter the market.
Margin rates vary depending on the broker and the instrument being traded, with more volatile assets typically requiring higher margin. For example, if a currency pair has a 3.34% margin requirement, you need only 3.34% of the total trade value in your account to execute the trade. This system enables traders to control larger positions with relatively limited capital, amplifying both potential gains and potential losses.
Margin trading allows you to invest amounts larger than the funds in your trading account by borrowing capital from the broker, effectively leveraging your positions to increase potential profits. When trading CFDs on margin, both your gains and losses are calculated on the full value of the position, not just your initial deposit.
While leverage can significantly amplify profits, it equally magnifies losses if the market moves against you. This makes margin trading a double-edged sword: high leverage combined with volatile markets can lead to rapid losses, sometimes exceeding your initial deposit. However, some brokers offer risk management tools like negative balance protection, which absorb losses beyond your deposit and reset your account balance to zero, preventing you from owing additional money.
What does the term “leverage” mean?
In CFD trading, leverage refers to the ratio between the total size of a trade and the margin amount required to open it. For example, a leverage ratio of 1:20 means you only need to deposit one-twentieth of the trade’s total value as margin. To place a $20,000 trade with 1:20 leverage, your margin requirement would be $1,000. This margin is essentially the portion of the total trade value you must have in your account to open and maintain the position.
Leverage magnifies both profits and losses, and many retail traders lose their margin quickly due to excessively high leverage. Beginners are advised to use lower leverage ratios to reduce the risk of wiping out their accounts during a series of incorrect market predictions. The leverage ratio can be calculated as L=A/EL = A / E, where LL is leverage, AA is the asset amount, and EE is the margin or equity. Conversely, the size of a position can be determined using A=E×LA = E \times L.
Leverage availability also depends on the trader’s classification. Retail traders usually face stricter limits—for example, 1:30 on Forex pairs in regulated jurisdictions—while professional traders can access much higher leverage, such as 1:100, 1:500, or even 1:1000 in some regions, provided they meet strict experience and asset requirements. To protect retail clients, regulatory authorities such as ESMA in the EU and the FCA in the UK have imposed maximum leverage caps for CFD trading.
- Major Forex pairs – up to 1:30;
- Minor and Exotic Forex pairs, Gold, and Major Stock Indices – up to 1:20;
- Commodities (excluding Gold) and Minor Stock Indices – up to 1:10;
- CFDs on Government Bonds – up to 1:10;
- CFDs on Stocks – up to 1:5;
- CFDs on Cryptocurrencies – up to 1:2. Note that, in January 2021, the FCA prohibited selling Crypto CFDs to retail clients residing in the UK.
In the United States, CFD trading has been prohibited since the Dodd-Frank Act of 2011. However, US-based retail clients can still trade Forex pairs with a maximum leverage of 1:50 under CFTC regulations.
For example, consider an EU-based trader using leverage to trade Microsoft stock CFDs. With an account balance of EUR 100,000 and a leverage of 1:5, the trader gains exposure to EUR 500,000 worth of shares—five times the amount they could control without leverage. To maintain this leveraged position, the account balance must remain above the maintenance margin requirement, which in this case is 50% of the position, or EUR 50,000.
Initial margin and maintenance margin
The initial margin is the minimum amount of capital you must have in your account to open a CFD trade. As the value of your position changes due to profits or losses, your account balance will also fluctuate. If the balance drops to 80% of the initial margin, this triggers a “margin call,” requiring you to deposit additional funds before reaching the maintenance margin. If your account falls below the maintenance margin, your position will be automatically closed. At most brokers, the maintenance margin is set at 50% of the initial margin. The maintenance margin represents the lowest account balance needed to keep a leveraged position open. Its purpose is to protect both the trader and the broker from excessive losses. Every CFD trade involves an agreement with a counterparty, and both sides must ensure they can meet their financial obligations to cover potential losses.
The maintenance margin serves as a close-out level, indicating that your account balance is insufficient to maintain active positions. Before reaching this level, you must either add more funds or close some of your trades. If the maintenance margin is breached, the broker will automatically close your position. For instance, consider placing a long trade on the EUR/JPY currency pair, expecting the Euro to strengthen against the Japanese Yen. Suppose the total position value is EUR 10,000 at a rate of ¥131. You do not need the full EUR 10,000 in your account; instead, you are required to provide only 3.34%, or EUR 334, as the initial margin. As long as your available balance meets or exceeds this amount and is not tied up in other positions, you can open the EUR 10,000 trade.
The margin call is typically set at 80% of the initial margin. If your available funds drop below EUR 267.20 (80% x EUR 334), you will be required to deposit additional funds to restore your balance to the minimum EUR 334. For example, if you start with EUR 400 in your account and incur a EUR 140 loss, your balance drops to EUR 260, which is below the margin call threshold of EUR 267.20. You will receive a notification to add funds, but the trade remains active because it is still above the maintenance margin, which is EUR 167 (50% x EUR 334). If the EUR/JPY continues to decline and your losses reach EUR 240, your account balance decreases to EUR 160, falling below the maintenance margin. In this case, the broker will automatically close your position. Monitoring your account and maintaining sufficient funds can help you avoid margin calls and forced liquidation of your trades.
First, maintain your leverage exposure at a reasonable level by closely watching your position size. If you place a large-sized position relative to your account balance, then a small price change may lead to a large percentage change in the value of your account;
And second, make sure you always have more funds in your trading account than the broker’s margin requirement. If there is a margin requirement of $200, for example, for a particular trade, having at least triple (or even more) of that in your account may diminish the probability of receiving a margin call notification.
Buying on margin versus buying with cash
The most notable differences between buying on margin and buying with the use of a cash account can be presented as follows:
Buying on margin | Buying in a cash account |
You need to ensure only a part of the transaction value in your account when you place the trade | You need to ensure the entire transaction value in your account when you place the trade |
You can amplify your profits as well as your losses. They will equal the price movement of the particular asset class multiplied by leverage | Your profits and losses will not be amplified. They will be based on the price movement of the particular asset class |
Margin rates required will be different depending on the asset class | Margin rates will be of no importance since you are funding the entire transaction |
The amount of money you leverage is associated with borrowing costs or overnight holding costs | You will incur no borrowing costs |
You can place long and short trades in a margin account | To place short trades you will need a margin account |
Margined products, such as CFDs and spread betting, involve borrowing costs. This means that if you keep a leveraged position open overnight, you will incur overnight holding charges. At the end of each trading day, typically at 5:00 pm New York time, all CFD positions in your account are evaluated, and a holding cost is applied. These overnight fees depend on the asset class and the trade direction (long or short) and can be either positive (earning interest for holding the position overnight) or negative (incurring a charge).
Overnight holding costs are usually calculated based on the relevant interbank rate plus a small markup. Since interbank rates vary by country, the overnight costs will differ depending on the currency of the underlying asset. For instance, overnight fees on US stocks are calculated using the US interbank rate, whereas European stocks would follow the Eurozone interbank rate. This ensures that financing costs reflect the local market conditions of each asset.
To illustrate the difference between buying on margin and using cash, consider the following example. Suppose you want to buy 100 shares of Ford Motor Company at $27 per share, with a total transaction value of $2,700. A margin trader, however, would only need to deposit 20% of the total value, or $540, in their trading account to open the position. If the price of Ford shares rises to $32 and you sell, the total value becomes $3,200. Your profit is therefore $500 ($3,200 – $2,700). Since the margin required was $540, this profit represents a return of $500/$540 × 100% = 92.6%. By contrast, if you were trading a cash account with $540, you could only purchase 20 shares. Selling them at the same price increase would generate a profit of 20 × $5 = $100, which translates to an 18.5% gain.
CFD trading versus Stock trading
CFD trading | Stock trading | |
Long and short positions | Traders can profit from both long and short positions | Traders can profit only when the price rises (only from long trades) |
Trading hours | 24 hours a day, 5 days a week | Only during a stock exchange’s business hours |
Costs | Spreads, Commissions, Overnight financing charges | Commissions only |
Do traders own the underlying asset? | No | Yes |
Dividends | A cash adjustment will be applied for dividends | Yes, only if the particular company decides to pay such |
Leverage | Leveraged positions are allowed, but margin requirements vary depending on brokers’ regulation jurisdiction and the asset class. Max retail leverage in the UK and the EU is capped at 1:30 (which translates into a 3.3% margin requirement) | Traders cannot place leveraged positions |
Range of markets | A variety of trading instruments across asset classes such as Forex, Commodities, Stocks, Stock Indices, Crypto, Futures, Options, ETFs, Bonds etc. | Stocks and ETFs only. |
A key difference between trading stocks directly and trading shares of well-known companies as CFDs lies in ownership. When you purchase stocks, you actually add the company’s shares to your portfolio, which entitles you to dividends and grants voting rights at shareholder meetings. In contrast, trading CFDs does not confer any ownership of the underlying asset. Instead, CFDs allow you to speculate solely on the price movements of the shares, enabling potential profits from both rising and falling markets without holding the actual stock.
A simple CFD trading strategy based on Slow Stochastic and Relative Strength Index indicators
And finally, we present a simple and easy-to-understand trading strategy based on technical studies entirely. Let us take a look at the 1-hour chart of AUD/USD and deploy:
The Slow Stochastic Oscillator set as follows:
- time periods of 5, 3, 3
- oversold level of 25.00
- overbought level at 75.00;
The Relative Strength Index set as follows:
- time period of 7
- oversold level of 25.00
- overbought level at 75.00;
We will also be paying attention to certain candlestick setups.
To place a long trade, you will need to look for the following conditions:
The Slow Stochastic Oscillator and the Relative Strength Index are both below their midpoint level and near their oversold levels;
There is a bullish candle (green), whose closing level is at the midpoint of the previous bearish candle (red).
To place a short trade, you will need to look for the following conditions:
The Slow Stochastic Oscillator and the Relative Strength Index are both above their midpoint level and near their overbought levels;
There is a bearish candle, whose closing level is at the midpoint of the previous bullish candle.
To exit your short trade, you will need to look for the following:
The Slow Stochastic Oscillator and the Relative Strength Index are both in their oversold areas;
There is a bullish candle, whose closing level is at the midpoint of the previous bearish candle.
You may look for the opposite scenario to exit your long trade.
Conclusion
CFDs provide an attractive alternative to traditional markets, allowing traders to generate profits despite the inherent high risks. While they offer advantages such as lower margin requirements, easier access to global financial markets, minimal or no fees, no shorting restrictions, and no limitations on day trading, they also carry notable drawbacks. High leverage can magnify both gains and losses, and paying the bid-ask spread when opening and closing trades can reduce profits if the price does not move sufficiently.
To manage your risk effectively, pay careful attention to your leverage ratio, ensure your account has enough funds to meet the broker’s margin requirements, and avoid risking more than 1%–2% of your total account balance on a single trade. Additionally, always utilize the risk management tools provided by your brokerage, including Stop Loss orders, Trailing Stops, and Guaranteed Stops, to help protect your capital and control potential losses.
