CFD trading is a form of market speculation where the trader forms a contract with the broker instead of purchasing an asset. Unlike traditional investing, traders don’t own the asset they are speculating on, and they don’t impact markets directly.
In short, that would answer the question in our title. However, for a newer trader, that explanation doesn’t suffice. You may wonder what sort of contract is being formed, how traders can profit without owning assets, or how they can trade on markets without impacting prices. You may be a bit more advanced and wondering about practical things, like where and how you can trade CFDs. We’ll answer all that and more in this article to help you learn about CFDs and form a well-rounded foundation for your trading knowledge.
Trading without ownership: The underlying mechanism of trading CFDs
When you read an explanation like the one in the first paragraph of our article, you may be intimidated by how it sounds. Underlying asset ownership and contracts sound quite formal, but the entire concept is simple.
CFD is short for contract for difference. In essence, it’s a contract whose price is linked to an existing asset on the market. So, in traditional trading, you’d be buying Meta stock, and in CFD trading, you’d be buying a Meta stock CFD. Their prices, of course, would be nearly the same.
The difference is that, in the case of buying shares in traditional markets, you’d own an actual portion of the company. You’d be buying from its limited pool of stocks and thus would impact the market price, and if you bought enough, you could become a board member.
With CFD trading, you’d be buying a contract with your broker. That means you aren’t connecting with the actual market, aren’t impacting the price directly, and aren’t affecting supply or demand. However, your broker will most likely keep prices nearly identical to the actual market. As such, functionally, the differences between CFD trading and traditional trading are negligible unless you’re purchasing a massive number of shares.
Trading Examples
To understand CFD trading, let’s take a look at how a traditional trade would look:
- You use a broker to connect to the market.
- You buy an asset from the market.
- You now own the asset – for instance, if you buy enough shares, you could actually become a board member or own a significant portion of the company.
- You can sell the asset at your leisure.
And for a CFD trade:
- You use a broker to access their CFD asset library.
- You buy a contract from the broker.
- You execute the contract at your leisure.
The question, of course, becomes, why would someone trade CFDs over traditional assets? If the only difference is that you own the thing you’re buying, why wouldn’t you go for traditional trading? And while there isn’t a notable difference in the actual trading process, many surrounding things are easier, more accessible, or more beneficial with CFDs.
Why traders choose CFDs
The number one reason most traders choose CFDs is that they are much more accessible. In traditional trading, everything you do goes through institutions called exchanges, and most only let you access domestic products. So, for a non-US citizen, buying the Amazon stock we mentioned might mean jumping through quite a few hoops.
CFD brokers, however, are accessible mostly wherever you are. As such, you can just open your trading platform and have top global assets at your fingertips. For many traders, these brokers are the only way to access top trading instruments.
In a similar vein, traditional trading in international markets often incurs additional fees. That may make prices much higher than accessing the same asset via CFDs. CFD trading usually offers a spread-based structure, which, for most traders, ends up being cheaper.
The next thing is convenience. Often when you trade traditionally, your brokerage will normally offer only a single asset class or at most a couple. CFD brokers usually have a full suite of assets – forex, stocks, indices, commodities, and perhaps more — letting you diversify your portfolio while keeping all your assets in a single space. This isn’t only more convenient from a usability standpoint but also makes portfolio and trading history analysis much easier.
Finally, the CFD brokerage industry is very competitive, forcing brokers to grow and innovate. For instance, features like Islamic accounts and social trading are seldom available at traditional brokers, but you can access them here at Xlence. As such, traders may find the entire experience more versatile and comfortable.
Why traders wouldn’t choose CFDs
To remain entirely impartial, we also need to outline why some want to steer clear of CFDs. The first reason is that some simply want asset ownership. If you want to become a major shareholder or benefit from dividends, traditional trading is definitely the better option. However, if you’re at that stage of your trading career, we’d wager your knowledge already expands beyond this article.
Another issue is that the CFD space can be dangerous. There are bad actors preying on inexperienced traders and getting away with scams. However, if you follow general internet safety rules, stick with popular options first, and avoid promises that sound too good to be true, you won’t have much to worry about.
What CFDs can you trade?
Anything you can buy on traditional markets, you can buy as CFDs. Some of the most popular CFDs are:
- Stocks: Shares from global companies
- Indices: Stock compendiums that evaluate market segments instead of individual companies
- Commodities: Consumer and industrial goods, often split into three categories (metals, energies, agricultures)
In the vast majority of cases, you’ll also find forex assets with CFD brokers. These classes cover most of the market, although some brokers go above and beyond. For instance, here at Xlence, you can also access futures.
Where to trade CFDs
Since you’ve found your way to our blog, Xlence is a great way to access CFDs for all of the markets we mentioned. However, you may also want to research other options. Just searching „Country CFD broker“ for your own country will likely give you tons of results.
Finding a broker that suits you as a beginner, however, is a process of trial and error. For starters, you’ll want to stick with well-known options with a formed online reputation from users and professional outlets alike. Regulation, additionally, reduces the chances you’ll run into a dishonest brokerage.
Other than that, factors you may want to consider are spreads (the lower the better), account options, platform, and asset availability. Most of these depend on personal preference, and to find your preference, you’ll have to experiment.
Your first CFD trading experience
What’s left to cover are the actual steps you’ll take when starting out with CFD trading. For starters, you’ll most likely want to trade with a demo account. To do this, find a broker that offers a demo. After that, you’ll most likely be able to register with some simple personal info, and you’ll receive your credentials and be able to trade on a test platform with virtual funds. These funds can’t be withdrawn, so they are only there for you to practice.
Once you start your actual trading journey, your broker will likely require you to go through a KYC process. This is part of their due diligence, and may require photos of your personal ID and bills as proof of residence. Keep in mind that the process may take a few days.
And that’s it; you’re then officially a CFD trader! The process, once broken apart into smaller steps is quite simple and not nearly as frightening as reading about complex financial concepts in theory. And while trading is a matter of constant self-improvement, the first step is a big one, and we hope this article helped you take yours!
Disclaimer:This information is not considered investment advice or an investment recommendation, but instead a marketing communication.
