CFD or Contracts for Difference Trading Guide

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CFD trading can be both profitable and risky. Our team of experts wants to make it easy for you, so we have put together this table of the best CFD brokers to trade CFDs. Don’t risk more than you should and choose regulated CFD brokers.

Best CFD Brokers 2021

What is a CFD?

CFD stands for Contract for Difference. It involves trading on the change in the price of an asset between the opening and closing time of the contract, but without actually owning the underlying asset. Ergo, when two parties sign a CFD, what they are agreeing to do is (very simply put) to exchange the difference between the entry price and the exit price of the asset.

After this rough explanation we would like to make it clear that CFDs are complex instruments and understanding how they work is not that simple. But if you really want to learn how to trade CFDs, you will find all the information you need below.

What is CFD trading?

CFD trading is a short-term speculative investment, which aims to make a profit thanks to the movement of asset prices. Its main characteristic is that it is usually carried out in very short periods of time, a few days at most, although CFD trading usually opens and closes the position in the same session, often lasting only a few seconds or minutes.

Given the short-termism of investing… Can you make big profits from CFD trading? Yes (and you can also lose money quickly, it must be said). This is because of two essential peculiarities of CFDs: the possibility of opening long and short positions and the fact that they allow leverage.

How to trade CFDs Long and short positions

One of the basic characteristics of CFD trading is that it is not about buying or selling the underlying asset, but about speculating (guessing) how the price of that financial instrument will move (either up or down). To explain it even more clearly. This is how CFD trading works:

  • If you expect the price of the underlying asset to rise, you will open a long position. Therefore, you will buy CFDs and if, as you have anticipated, the price moves upwards, you will make a profit proportional to the change in price that has occurred from the time you opened the position to the time you close the position.
  • If, on the other hand, you believe that the price will move downwards, you will open a short position. In this case, you will sell CFDs and the profit (provided your bearish forecast was correct) will be proportional to the depreciation of the financial instrument. This is called short trading.
  • In the two cases above, we have considered the option that things are going well and your predictions are correct. But this is not always the case. When the price moves contrary to the position you have taken, the loss will (equally) be proportional to this price movement.

As a very short conclusion: the profit or loss you will make will always depend on how big (or small) the price change was. Ergo, there are options to make more profit (and also more loss) in financial markets with high volatility.

Advantages of CFDs

  • Variety of assets: there is a wide variety of financial instruments that can be traded with CFDs, e.g. stock indices; commodities such as gold, oil or metals; Forex or currency pairs… Many of these are inaccessible to the vast majority of retail investors, either because of a direct restriction or because they require such high investment amounts that they are prohibitively expensive.
  • Short or long position: Earlier we talked about the two possibilities you have when opening your CFD trading position, depending on whether your price forecast is bullish or bearish. In other words, there are options to make a profit, whether the price goes up or down. In the second case (price decline), the simplicity of operation is particularly significant, especially in contrast to other products that allow you to trade downwards, but with much more rigid and complicated conditions.
  • No expiry date: little else to say, there is no expiry date and this is undoubtedly another advantage of CFD trading.
  • Dividends associated with the asset: in CFD trading you will receive dividends associated with the asset on which you have speculated, namely 100 % when the position is short (bearish), and 80 % if it is long (bullish).
  • Leverage: We always make it clear that this is an advantage and also a risk. Thanks to leverage you can trade in financial markets with much more money than you have actually invested and the profits will be proportional to that fictitious amount. But, beware, so are the losses. Never lose sight of this when trading with a leveraged product.

Risks of CFDs

We continue with the warning that closed the previous section. When trading CFD’s you can make significant profits, but you can also make large losses. Keep in mind one detail that is absolutely fundamental: to lose all the money when trading conventional shares, the price of these should remain at 0. If they cost 10 euros, they would have to go from 10 to 0. This is highly unlikely.

But not with CFDs, in these operations it is enough that you are not correct in your prediction. In other words, if you have taken a buying position because you believe that the price of the financial instrument is going to rise, and it turns out that it falls, even if it is only one point (from 10 to 9), you lose everything. And exactly the same the other way around: if it goes from 10 to 11 euros (price increase) and your position was a sell position because your prediction was for a downward price movement, you will also see your account go to zero.

How to avoid the risks of CFDs?

It is important that you try to avoid taking on a high risk that is harmful to your investments. For this purpose, some CFD brokers offer the option of limiting your losses in exchange for a higher commission. There are also some trading platforms that close the client’s positions if he/she loses all the money in his/her collateral.

Be well informed before you start trading CFDs, limit your losses by using brokers with negative balance protection and heed the maxim that “you shouldn’t invest money you don’t have”. Never invest more than you can afford to lose. With this basic investment strategy, which is simple common sense, you will be able to invest reasonably.

Types of CFD brokers

There are two main types of brokers for CFD trading:

  • DD (Dealing Desk): these brokers have their own dealing desk. This means that the trades made with them do not reach the market, as they themselves act as counterparties. They are called Market Makers. The main problem they present is that, by acting as a counterparty, a conflict of interest arises between their profit and ours.
  • NDD (No Dealing Desk): brokers that do not have a dealing desk and therefore act as mere intermediaries. They do not provide a counterparty and take trades to the financial market.

Some types of NDD brokers are:

  • ECN (Electronic Communication Network): the broker simply offers his client the best bid and ask prices (Bid and Ask respectively). The orders given by the client are transmitted directly to the market. They are the most ideal type of CFD broker for experienced traders and allow scalping, hedging and automatic trading without restrictions.
  • STP (Straight Through Process): as in the previous case, they limit themselves to transmitting the client’s order to the market. They cannot modify the prices and give the best Bid and the best Ask, but separately (explained later).
  • DMA/STP: are an enhanced version of STP brokers. They provide direct access to the best prices and allow various types of CFD trading such as hedging, swing trading and so on.

Difference between ECN and STP

Here comes the promised explanation: ECNs offer the best bid price (Bid) and the best ask price (Ask) by looking for the lowest spread (the difference) that is currently available in the market. Let’s say that Bid and Ask are searched together.

But in the case of STP brokers this is not the case: the best Bid and Ask are given separately, which can lead to negative spreads (to this spread, however, the STP broker adds its commission).

CFD BrokersLicenceFounding yearDemo AccountMinimum deposit
XTBCNMV, FCA2002Yes100
AvaTradeCBI, BVI FSC, FSP, FSA, FFAJ2006Yes100
eToroCySEC, FCA, ASIC2007Yes200
PepperstoneCySEC, BaFIN, FCA, ASIC2010Yes200
Plus500CySEC, ASIC2008Yes100
Admiral MarketsCNMV, FCA, CySEC, ASIC2001Yes200
IC MarketsASIC2007Yes200

Comparison of CFD brokers

CFD leverage limits

On 1 August 2018, the new regulation of the European Securities and Markets Authority (ESMA), known as “product intervention“, which aims to protect retail investors, came into force. ESMA is an institution that oversees the European financial system and ensures stability, transparency and integrity in the markets.

ESMA considers CFDs to be complex and risky instruments and therefore fears that not all investors are prepared to trade them. It has therefore differentiated between retail and professional clients and, for the former, has set a series of limitations in order to try to mitigate the losses that may be incurred due to their limited experience.

These limitations largely relate to maximum leverage limits, which will vary depending on the asset being traded:

  • Leverage of 1:30 for major currencies.
  • 1:20 leverage for indices and Gold.
  • Leverage of 1:10 in the case of commodities.
  • Leverage of 1:5 when trading equities.
  • 1:2 leverage on cryptocurrencies.

In addition, ESMA has introduced further restrictions, which can be summarised as follows:

  • Prohibition of binary options.
  • A position shall be required to be closed if the deposit of funds is less than 50 % of the original deposit.
  • Limitation of incentives associated with CFDs (Bonds).
  • Regulation limits the range of incentives offered in connection with CFD transactions.
  • Negative balance protection becomes mandatory.
  • Standardisation of risk. All brokers will be obliged to inform the investor of the risk of capital loss.

As for professional clients, who must meet a number of (not light) requirements to be considered as such, they may trade with a maximum leverage of 1:500.

It should be noted that these measures apply only to CFD traders who are resident in Europe. None of the limitations will therefore affect, for example, Latin American users.

CFDs vs Futures

We could go into much more detail on this, but broadly speaking, for medium-low investors (retail investors) the best option is CFDs. The main reason for this is that although Futures do not initially require a large investment, in the long run they can entail significant costs.

External references

  • Wikipedia – Contracts for Difference
  • Comisión Nacional del Mercado de Valores (Spanish Securities and Exchange Commission)
  • European Banking Authority
  • European Security and Markets Authority