A CFD, short for ‘Contract for Difference,’ is a type of financial derivative that allows traders to speculate on the price movements of various underlying assets, such as stocks, commodities, currencies, or indices, without owning the actual underlying asset.
A wide variety of products and assets can be traded as contracts for difference. In this market, the main types of CFDs include:
When trading a CFD, you enter into a contract with a broker to exchange the difference in the price of the underlying asset between the opening and closing of the contract. If you believe the market price of the asset (e.g., forex currencies, stocks, commodities) will rise, you can go long (buy), and if you expect it to fall, you can go short (sell). The profit or loss is determined by the difference in the price movement of the asset in the open market.
CFD trading works by allowing you to speculate on the price movements of a financial instrument without having to take ownership of the underlying asset. If the market price of the asset moves in the same direction as your CFD trade, you will make a profit.
There are two prices to look for in a CFD trade: the “buy” price and the “sell” price. The action you choose to take will depend on whether you think the price will rise or fall.
Let’s explore that concept using some examples:
A key advantage of CFD trading is the accessibility it provides to a wide range of markets and assets. With CFDs, traders can access various financial instruments, including stocks, indices, commodities, and currencies, all from a single trading platform. This means traders can diversify their portfolios and take advantage of opportunities in different markets, even if they don't have direct access to those assets. The ability to trade on margin also enhances accessibility, as it allows traders to control larger positions with a smaller amount of capital, potentially amplifying their potential returns.
Note: Trading with leverage can also amplify losses, so strict risk management practices should be followed.
CFD trading also offers flexibility and the opportunity to profit from both rising and falling markets. With CFDs, traders can take long (buy) positions if they expect an asset's price to rise or short (sell) positions if they anticipate a price decline. This means that traders can potentially profit from market movements in either direction, enabling them to capitalise on different market conditions.
CFD trading is available to anyone who has opened a trading account with an online broker. Once the account has been set up, you can use the following general guide to help with setting up a standard CFD trade:
Both CFD and traditional trading (for example, buying stocks) provide exposure to share price movements. However, there are some key differences between the two.
When you trade or invest in shares, you take direct ownership of an asset, usually company stocks. In this case, you can only make a profit by selling your shares at a higher price than what you bought them for.
With CFD trading, you are only trading price movements, so you can go long (buy) or short (sell) on instruments on a variety of global markets, such as stocks, commodities, forex, and indices. This enables you to potentially profit or lose from price fluctuations on the market without owning the underlying asset.
Another key difference between the two is the use of leverage. CFDs are leveraged products, meaning you effectively put down a small percentage of the capital required to open a full trade position, and then borrow the rest from your broker. This allows you to use a small amount of money to potentially make significantly higher returns (or losses). With stock trading, you use your own money to buy a stock, and you are required to pay the full upfront price.
CFD trading |
Traditional trading |
Use leverage | Pay the full upfront price |
Multiple markets | Equities and ETFs |
You do not own the underlying asset | Ownership of the underlying asset |
Go short and benefit from falling prices | No option to benefit from falling prices |
No shareholder privileges | Shareholder privileges and voting rights |
No stamp duty, but profits are liable for capital gains tax | You pay stamp duty and capital gains tax on your profits |
Option to hedge your trades | Hedging requires the use of derivatives (options, futures, and inverse ETFs) |
In trading, you can have the best strategy in the world, but without risk management, it is hard to stay profitable in the long run. Markets are volatile, so risk management is essential.
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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.
FAQ
Certain countries do not allow CFD trading. If your country of residence is not displayed on the online application form when opening a trading account, you cannot do so.
As with any financial instrument or investment, trading CFDs comes with a risk. The use of leverage can make CFDs riskier than non-leveraged products, such as physical shares. Before you start trading with a live account, you should familiarise yourself with those products, practise in a risk-free environment, and learn more about risk management.
The minimum trade size for Standard and Pro accounts with Axi is 0.01 lots. However, this number may change depending on the instrument you are trading.
Options and CFDs share some common characteristics. They can both provide high leverage, and flexibility can be used for both hedging and speculation. However, there are some major differences between the two. When you buy a CFD, you agree to exchange the difference in price from when you opened a trade to when you closed it. Options give a trader the right (but not the obligation) to buy or sell an asset at a certain price in the future. Options offer more flexibility, and traders can create complex strategies using these instruments.
A CFD depicts the price movement of an asset, which gives the investor a clear picture of the value changes that occur while holding a position open.
When a trader agrees to a futures contract, they agree to buy or sell the underlying asset at a predetermined price and date in the future. It is a contract that will be executed in the future, and the set price will stay unchanged, irrespective of the value movement of the asset. The buyer of a futures contract must execute the underlying asset when the contract expires. Consequently, the seller of the contract ordeal has the obligation to provide the asset at the agreed date.
Futures operate based on prices established by the markets as they are traded on exchanges, while CFDs work based on prices established by the broker. Thus, the integrity of the price is expected to be higher in the case of futures when compared with CFDs.
Simply put, futures can be considered a less flexible and more structured alternative to CFDs.
The point at which a CFD contract matures is called the CFD contract rollover date. A futures contract's expiration date serves as the last day you can trade that particular contract.
Before contract expiry, a futures trader has three options: offsetting or liquidating the position, settlement, or rollover. A rollover is when a trader moves their position from the front-month contract (close to the expiration date) to another contract date further in the future to avoid the costs or obligations associated with the settlement of the contracts. Contract rollovers are profit-neutral.
Note: A CFD contract rollover date is not applicable to all trading products.
The decision to trade CFDs versus invest in stocks is up to the individual and their financial means and goals.
Share CFDs allow you to utilise leverage when trading the movement of stock prices, meaning you have the potential to make higher profits with a smaller amount of capital. While this can increase returns, it also increases risk. Trading share CFDs allows flexibility; you can go long (buy) when you expect prices to go up or go short (sell) to profit from falling stock prices.
However, with CFDs, you will not have any voting rights, and the tax liabilities might differ from those of physical shares, depending on your country of residence.
Axi provides access to a wide range of markets for CFD trading. Please refer to our Product Schedule for a full list of CFD trading instruments.