CFD, which stands for a Contract For Difference, is a very popular form of derivative trading. It enables the trader to speculate on the rising and declining prices of markets—especially rapidly-moving markets. The trader can also speculate on the price fluctuations of such instruments as treasuries, shares, currencies, commodities, and indices.
With CFD trading, people are able to trade on margin. They can also go short if they believe that prices will fall or long if they think prices will go up. To go short means to sell, while to go long means to buy. One major appeal of CFD trading is that, in most countries, it is done without having to pay certain transaction-based taxes (for example, in some places, you do not pay stamp duty).
However, tax laws vary by country, and capital gains tax may still apply in some regions. In the United States, for instance, retail traders generally cannot trade CFDs due to regulatory restrictions.
What are derivatives?
Derivatives are contracts whose values come from the performance of underlying entities. They are securities that we link to stocks, bonds, and other financial instruments. We may also link derivatives to real estate, exchange rates, or a currency exchange.
Derivatives themselves are not worth anything on their own. Their value comes from the primary security they are tied to.
We use derivatives for many different purposes, such as raising exposure to price movements for speculation, gaining access to otherwise difficult-to-trade assets or markets, as well as for hedging (reducing the risk of unwanted price swings).
CFD trading – how does it work?
CFD traders do not buy or sell the underlying asset, such as a currency pair, commodity, or physical share. Instead, they purchase or sell a specific number of units for a type of instrument depending on which way they think prices will move, i.e., up or down.
Put simply, CFD trading is a way to make money by speculating on the predicted price movements of treasuries, commodities, and other financial instruments—without ever directly owning them. Traders gain or lose multiples of the number of CFD units they possess. If the units’ prices move in their favor, they gain money. If the prices move against them, they lose accordingly.
Because CFDs are traded on margin, if the market moves significantly against a trader, the broker can issue a margin call, requiring the trader to deposit more money. If the trader fails to do so, the broker may close positions automatically to limit further losses.
Creating a CFD Trading account
Many online firms have facilities for opening a CFD trading account. Applying for one is a straightforward process that usually does not take more than a few minutes.
As soon as your details have been verified, you will need to place money in your account. You can do this via PayPal, BPay, or debit/credit card. Some traders prefer to practice first with virtual funds (i.e., not real money). If you want to start off without risking your money, you should consider opening a demo account. Many firms offer this option, providing a chance to get comfortable with the platform and market movements before risking real capital.
CFDs are a flexible way to speculate on multiple markets—treasuries, shares, currencies, commodities, and indices—often tax-efficient in certain places. Still, their high risk (due to market volatility and leverage) means they can yield significant profits or losses. For anyone interested, especially newcomers, it’s wise to learn through a demo account and approach CFD trading with caution.