What are CFD stocks and how do they work?

CFD Trading

Contract for difference (CFD) trading is when a contract is made between an investor and an investment bank. When this contract comes to an end, the parties involved will exchange the difference between the opening and closing prices of the chosen financial market. CFDs tend to be the most attractive to day traders, as they already use leverage to trade assets, particularly those that are more expensive to buy and sell.

CFDs are an advanced trading strategy that is best suited to more experienced traders, who prefer to trade in short-term stock movements. Another reason that trading in this way can be so attractive, is that you have the opportunity to benefit not only from rising prices, but also trading losses.

Read on to find out more.

What?

CFDs allow investors to trade in the form of the price movements of securities and derivatives – whether the stock’s worth will rise or fall over time. If a trader expects that a stock will move upwards in price, then they will opt to buy, whilst if they predict a decline, they will most likely sell.

If sold, the net difference between the purchase price and sale price will be brought together, before being settle though the investor brokerage account, therefore identifying the profit. Similarly, if you believe that a stock’s price is set to decline in the near future, you can go on to place an opening sell position, closed when you also purchase an offsetting trade. The net difference is then settled through that same brokerage account.

Unlike physical shares or currency pairs, you aren’t buying or selling an underlying asset with CFD trading. Instead, you’re buying and selling a number of units for a financial instrument. In a nutshell: for every stock that moves in your favour, you’ll gain multiples of the original CFD units that you’ve bought or sold, whereas, you’ll make a loss if the price moved against you.

How?

CFD trading is relatively easy to do, although it may sound daunting at first. To help you get to grips with the basics, here are five easy steps to get you started.

1. Choose a market

First, you need to decide which market you want to trade in. You can easily find a wide selection of trading options from online stock trading platforms such as Plus500 – if you’re unsure of where to invest.

2. Decide whether you want to buy or sell

If you think that a stock is going to increase in value then you will want to “buy”, whereas if you predict a fall, then you will want to “sell”.

3. Select your trade size

Choose how many CFD units that you want to trade. Keep in mind that one CFD unit is the equivalent to one physical share in equity trading.

4. Add a stop loss

A stop loss is always a good idea, as it ensures that your position is closed when the value reaches a certain price, should it move against your trade. This limits your losses, and acts as somewhat of a safety blanket.

5. Monitor and close your trade

Once you’ve chosen and placed your trade, you can monitor your profits and losses in real time on your preferred trading site.

It’s worth noting that buying or selling can also be referred to as “going long” or “going short”. There’s also no fixed contract size with CFD trading, with instantly tradable prices for the majority of deals. What’s more, you can trade at any time as there are no fixed expiry dates, as well as no Stamp Duty when you trade in the UK.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.