What is CFD trading and how does it work?

While you might be familiar with investing and trading shares, contracts for difference (CFDs) offer a number of advantages that may be attractive for your ambitions to grow your wealth over the long term. At the same time, there are risks involved when trading a complex instrument, so it’s important to do your due diligence and plenty of research. 

A contract for difference is a financial derivative product that pays the difference in settlement price between the opening and closing of a trade. CFD trading enables you to speculate on the rising or falling prices of fast-moving global financial markets (or instruments) such as shares, indices, commodities, currencies and treasuries. 

What are CFDs? 

CFDs, short for contracts for difference, are financial derivative products that allow traders to speculate on price movements, usually in the short term. They are contracts between an investor and an investment bank. At the end of the contract, the parties exchange the difference between the opening and closing prices of a specified financial instrument, which can include forex, shares and commodities. Trading CFDs means that you can either make a profit or a loss, depending on which direction your chosen asset moves. 

CFDs vs stocks 

CFDs and stocks differ fundamentally in their structure and purpose. When you buy a stock, you own a share of the company, giving you rights such as dividends and voting power. By contrast, CFDs are derivative instruments that let you speculate on price movements without owning the underlying asset. 

Moreover, CFDs offer leverage, which means you can control a larger position with a smaller capital outlay, unlike stocks, where you need to pay the full value upfront. CFDs are also bidirectional, which means traders can profit from both rising and falling prices, whereas stock investors traditionally benefit only when prices rise. 

The costs and fees also vary when considering CFDs vs stocks: stock trading tends to incur brokerage fees and potential dividend taxes, while CFDs can involve spreads, overnight financing and commission. Finally, CFDs can often be traded outside regular market hours, which offers greater flexibility than just trading stocks during periods when the exchange markets are open. 

Advantages of CFD trading 

One of the benefits of CFD trading is that you can use margin trading, which lets you open larger positions with a smaller capital outlay. Having this leverage can amplify your market exposure but also requires careful risk management to avoid bigger losses. 

CFD trading is also bidirectional, meaning you can profit from both rising and falling markets. If you anticipate a price increase, you can go long (buy), and if you expect a decline, then you can go short (sell). It’s this type of flexibility that presents new opportunities in all market conditions. 

Another advantage of CFDs is being able to hedge an existing portfolio. If, for example, you own stocks and expect their value to drop temporarily, you can use CFDs to offset potential losses. CFDs also cover a wide range of markets, including indices, forex, commodities and cryptocurrencies, which are all accessible from a single trading account. 

CFDs also provide flexibility in trading timeframes, especially when compared to stocks. Traders can adopt long-term positions or employ day trading strategies, depending on their goals and market outlook. 

Learn more about the benefits and risks of CFD trading with our CFD advantages and risks guide. 

How does CFD trading work? 

When you trade CFDs, you don’t buy or sell the underlying asset (e.g. a physical share, currency pair or commodity). We offer CFDs on thousands of global markets, and you can buy or sell a number of units for a particular product or instrument depending on whether you think prices will go up or down. Our wide range of products includes shares, currency pairs, commodities and stock indices. 

Wondering how CFDs work? For every point the price of the instrument moves in your favour, you gain multiples of the number of units you have bought or sold. For every point the price moves against you, you will make a loss. Please remember that for retail clients, you could lose up to the amount of your deposit. 

Margin and leverage 

Contracts for difference (CFDs) is a leveraged product, which means that you only need to deposit a small percentage of the full value of the trade in order to open a position. This is called ‘trading on margin’ (or margin requirement). While trading on margin allows you to magnify your returns, your losses will also be magnified as they are based on the full value of the position. This means that you could lose all of your capital, but as the account has negative balance protection, you can't lose more than your account value. 

Learn more about CFD margins and how to calculate CFD margins. 

Short-selling CFDs in a falling market 

CFD trading enables you to sell (short) an instrument if you believe it will fall in value, with the aim of profiting from the predicted downward price move. If your prediction turns out to be correct, you can buy the instrument back at a lower price to make a profit. If you are incorrect and the value rises, you will make a loss. This loss can exceed your deposits. 

Hedging your physical portfolio with CFD trading

If you have already invested in an existing portfolio of physical shares with another broker and you think they may lose some of their value over the short term, you can hedge your physical shares using CFDs. By short-selling the same shares in CFDs, you can try to make a profit from the short-term downtrend to offset any loss from your existing portfolio. 

For example, if you hold $5,000 worth of physical ABC Corp shares in your portfolio, you could short-sell the equivalent value of ABC Corp with CFDs. Then, if ABC Corp’s share prices fall in the underlying market, the loss in value of your physical share portfolio could potentially be offset by the profit made on your short-sell CFD trade. You could then close out of your CFD trade to secure your profits as the short-term downtrend comes to an end and the value of your physical shares starts to rise again. 

Using CFDs to hedge physical share portfolios is a popular strategy for many investors, especially in volatile markets. 

How to get started with CFD trading 

Here’s a quick guide to help you get a handle on CFD trading basics: 

1. Choose a broker and sign up: Pick a reputable broker that offers CFDs across a variety of markets. If you’re new to trading, many brokers will let you open a demo account, which you can use to practise different strategies and familiarise yourself with the platform using virtual funds. 

2. Fund your account: After signing up, deposit funds into your trading account. Make sure you meet the broker’s minimum deposit requirements and remember to only commit capital you’re prepared to trade with – and potentially risk losing. 

3. Explore the platform: Take time to navigate the trading platform, learning about its tools, charting features and order types. Most brokers will have tutorials and resources to help guide new users. 

4. Select markets: Decide which markets you want to trade in. There are many types of CFDs to choose from, but popular choices include forex, shares, indices, commodities and cryptocurrencies. Trading CFDs means you can easily diversify your trades across multiple asset classes. 

5. Start buying/selling: Use your own analysis to place your first trade. Decide whether to go long (buy) or short (sell) based on market expectations. 

6. Monitor and manage positions: Regularly track your trades, making adjustments wherever needed to manage risks and lock in profits. For more control, you can use stop-loss and take-profit orders. 

With CMC Markets, getting started is easier than ever. Our next-generation platform has intuitive navigation and advanced tools while giving you broad access to diverse markets. It doesn’t matter whether you’re a beginner or an experienced trader, CMC has a library of resources like educational guides, demo accounts and real-time insights to support your trading ambitions. 

What are the costs of trading CFDs? 

Spread: As in all markets, when trading CFDs, you must pay the spread, which is the difference between the buy and sell price. You enter a buy trade using the buy price quoted and exit using the sell price. As one of the leading CFD providers globally, we understand that the narrower the spread, the less you need the price to move in your favour before you start making a profit or loss. Our spreads are, therefore, always competitive, so you can maximise your ability to net a potential profit. 

Holding costs: At the end of each trading day (5 pm New York time), any positions open in your account may be subject to a charge called a 'holding cost'. The holding cost can be positive or negative depending on the direction of your position and the applicable holding rate. 

Market data fees: To trade or view our price data for share CFDs, you must activate the relevant market data subscription, for which a fee will be charged. 

Commissions (only applicable for shares): Trading CFDs in Australia? You must also pay a separate commission charge when you trade share CFDs. Commissions on AUS-based shares on the CMC Markets CFD trading platform start from 0.09% of the full exposure of the position, and there is a minimum commission charge of $7. 

What instruments can I trade? 

When you open a CFD trading account with us, you can take a position on thousands of instruments, including CFD forex trading. Our spreads start from 0.5 points on forex CFDs, including the EUR/USD and AUD/USD currency pairs. See our range of markets. There is also the option to trade CFDs over traditional share trading, which means that you do not have to take ownership of the physical share. 

Develop confidence in CFD trading with CMC Markets 

Confidence is key to successful CFD trading, and CMC Markets has the tools and resources to help traders at all levels build it. Whether you’re a beginner or an expert trader, our user-friendly platform will support your growth and decision-making. 

For those new to CFDs, our demo account is a risk-free way to try out new trading strategies and learn about the intricacies of different markets. With access to real-time price data and virtual funds, you can develop your skills and test your knowledge without any financial risk. 

CMC Markets also offers a wealth of educational resources — from guides and tutorials to the latest market insights — so you can learn about important concepts like leverage, margin, and risk management. For more experienced traders, our platform has advanced charting tools, over 115 technical indicators, and customisable alerts so you can refine your strategies and stay ahead of market movements. 

With access to a wide range of markets, from forex and indices to commodities and cryptocurrencies, CMC Markets makes it easier than ever to explore and diversify your trading opportunities. 

CFD trading is a versatile way to tap into global markets, with opportunities to trade forex, indices, commodities, and more. Whether you’re looking to profit from rising or falling prices or hedge existing investments, CFDs offer plenty of flexibility and potential rewards. However, understanding the risks and strategies involved is key to trading with confidence. 

At CMC Markets, we’re committed to helping traders of all experience levels succeed. Our CFD Knowledge Hub is packed with guides, tutorials and expert insights to deepen your understanding of CFD trading basics and more complex strategies. For beginners, you can set up and start using a demo account to test trading strategies and build your skills with virtual funds.