Account

New to ADSS? Open an
account now to get started.

OR

Already have an account?

Add funds to your ADSS account

Account

New to ADSS? Open an
account now to get started.

Add funds to your ADSS account

Trends & Analysis
News
Mastercard’s shares decline despite upbeat results
News
Tesla’s stock surges after upbeat Q4 print
News
Is there a golden opportunity with Shopify?
News
Investors unimpressed by Microsoft’s earnings beat
News
How should you play the NASDAQ 100’s moment of truth?
News
Baker Hughes shares decline amid weak Q4 print
Trends & Analysis
News
Mastercard’s shares decline despite upbeat results
News
Tesla’s stock surges after upbeat Q4 print
News
Is there a golden opportunity with Shopify?
News
Investors unimpressed by Microsoft’s earnings beat
News
How should you play the NASDAQ 100’s moment of truth?
News
Baker Hughes shares decline amid weak Q4 print

Account
New to ADSS? Open an
account now to get started.
Open an account Login

Learn

04. How does CFD trading actually work?

Disclaimer: This article is an educational guide to CFD trading and the financial markets and should not be considered as advice. Trading CFDs is high risk. Always ensure you understand the potential risks and rewards associated with trading before you trade.

 

Open an account

 

While the popularity of CFD trading has grown steadily over the years, it spiked during the pandemic as a global phenomenon. Some studies show that interest in CFD trading skyrocketed 193% in 2020. Wondering why traders are choosing this instrument to speculate the financial markets? Let’s find out what CFD trading is, its inherent advantages and risks, and how it works.

 

What is CFD Trading?

Contracts for difference (CFDs) are derivatives, which means their value is derived from an underlying asset. For instance, gold CFDs derive their price from the yellow metal. CFDs offer a way to gain exposure to price movements in the underlying asset without the need to buy or sell it. For instance, if you’re bullish about gold prices rising from $1,700 to $1,800 , you can trade this difference in price using gold CFDs, without buying and holding gold until you sell it.

 

What are the Pros and Cons of CFD Trading?

Start small: Since you’re speculating on the difference in the price of an asset between the time the contract opens and closes, you can begin trading with a much smaller amount than buying the asset outright. For example, if you expect gold prices to rise from $1,760 to $1,770, you’re trading with $10, and don’t need $1,760 to buy an ounce of gold.

 

Access to a larger range of assets: There are CFDs for a variety of asset classes, including equities, indices, forex, commodities and cryptocurrencies. Moreover, CFDs allow you to trade assets that you otherwise may not have access to. For instance, day traders can access oil and other commodities with CFDs. This means you can trade all the major markets of the world, around the clock, from a single platform.

 

Trading opportunities in rising and falling markets: With CFDs, you can speculate on price movements in either direction (rising and falling), which means there are trading opportunities in both bullish and bearish markets.

 

Using leverage: CFDs offer much higher leverage than traditional trading, which allows you to gain the desired market exposure by depositing only a small fraction of the total value of your trade. For some underlying assets, the leverage could be as high as 500:1.

 

How Does Leverage Work in CFD Trading?

Let’s try to understand how leverage works and how it magnifies your profits if the market moves in the direction you had expected, or increases your risk if the market moves in the opposite direction.

 

Let’s say, you’re bullish about Tesla’s stock and wish to speculate on 10 shares. At $1,000 per share, the value of this exposure is $10,000. If you purchase these shares outright, you’ll need to find $10,000. Now, Tesla reports strong earnings and the stock rallies from $1,000 to $1,010. If you decide to sell the shares, you make a profit of $10 per share. Your total profit is $100. You made $100 on an investment of $10,000, which means your profit percentage is ($100/$10,000)*100, or 1%.

 

Keeping the total size of your position at 10 Tesla shares, let’s use leverage of 100:1. This means you need only $100 to gain exposure to $10,000 worth of Tesla stock. The broker lends you the remaining amount of $9,900. When the share price rises from $1,000 to $1,010 and you close the position, you still earn $10 per share, or $100 in total. However, you made $100 by depositing only $100 to open the CFD position. This means your profit percentage is ($100/$100)*100, or 100%.

 

Expert tip

When trading CFDs using leverage, it’s even more important to deploy robust risk management techniques, like stop loss and take profit, with every trade.

 

Another advantage of leverage is that it frees up your funds, which you can use to place other trades.

The Mechanics of CFD Trading

With CFDs, you can speculate on either direction of price movements of your chosen asset. If you expect the price to rise, you can open a long (or buy) position using CFDs. In case you expect prices to decline, you open a short (or sell) position. If the market moves in your expected direction, you earn a profit when the contract closes. In case the market moves in an unfavourable direction, you make a loss when the contract closes.

 

CFDs are traded in standardised contracts, known as lots. The lot size depends on the underlying asset being traded. CFDs typically do not have a fixed expiry, which means the position remains open till you choose to close it. To close the position, you are effectively opening another position in the opposite direction. For instance, if you had opened a long CFD position in silver after which silver prices rallied, you would be placing a sell trade to close your original long position to realise your profit.

 

The Mechanics of CFD Trading

To calculate the profit or loss on a CFD trade, you will need:

  • The standard size of 1 lot (also called the tick size)
  • The price of 1 lot (also called the tick value)
  • The price of the instrument when you opened the position
  • The price of the instrument when you closed the position

 

With this information, here are the steps to calculate the profit or loss on a CFD trade:

 

Step 1
Calculate the deal size by multiplying the tick size by the number of ticks (lots) you purchased.

 

Step 2
Multiply the deal size by the tick value.

Step 3
Multiply the figure achieved in step 2 by the difference between the price of the asset when you closed the position and when you opened it.

 

Profit or Loss = (deal size x tick value) x (closing price – opening price)

 

For instance, you purchased 50 Amazon CFDs with a tick size of 1, having a tick value of 1 USD. You opened the position when Amazon’s share price was $200 and closed the position when the share price reached $210.

 

Your profit will be calculated as: (50 x 1) x (210 – 200) = $500.

 

If, however, Amazon’s share price falls from $200 to $190, your loss will be calculated as: (50 x 1) x (190 – 200) = -$500.

 

From this figure, you can also deduct any associated costs, like overnight fees, to arrive at your actual profit or loss amount.

 

Key Takeaways

  • CFD trading allows you to trade price movements of an asset without buying or owning the underlying asset.
  • With CFDs, you can find trading opportunities in both rising and falling markets.
  • CFDs trade on leverage, which magnifies your profits, but also increases your risks.
  • With both long and short positions, your profit or loss is realised only when the position is closed.

 

Open a live account with ADSS and get access to the world’s largest assets with CFD trading.

Learn. Explore. Pursue more.

 

Join our trading community to access our free weekly webinars, and our library of tutorial videos and how-to guides. Designed to help you navigate the index, forex, equities, cryptocurrency and commodities markets, analyse the latest news and insights and become a better trader.

 

01. The Difference between Technical and Fundamental Analysis

 

Technical and fundamental analysis are the foundations of informed trading. Here’s what you need to know about them.

02. The Beginner’s Guide to Charts in Trading
 

Charts are an excellent way to gain insight into the markets at a single glance. They are powerful tools for online trading.

03. Things to know before placing a trade on MT4
 

Ready to start your trading journey with our bespoke version of the award-winning platform?

04. How does CFD trading actually work?
 

Why is CFD trading so popular? Learn how to use Contracts for Difference for trading equities, FX and more.

05. What are Indices and How Do You Trade Them?
 

Not sure what stocks to trade? Start with an index such as the Dax instead and trade a variety of them at the same time.

06. The basics of FX: six things to know when you start
 

Want to trade CFDs on forex pairs? Not sure where to start? Check out our beginner’s guide.

07. Apple? Tesla? Meta? How to start trading stocks
 

Want to know how to trade equities? Check out our simple guide on trading CFDs on some of the biggest companies in the world.

08. The Beginner’s Guide to Trading Commodities
 

Interested in trading gold, oil, silver and more? Learn about safe haven assets and more with our guide.

09. Four Things to Consider Before You Begin Crypto Trading
 

Planning on adding cryptos to your portfolio? Here’s our guide to navigating those notoriously volatile digital coins.

10. The Ultimate Trading Checklist: Pro tips to save you time
 

Ready to start trading? Learn about investing responsibly with our comprehensive guide.


Site by Pink Green
© ADSS 2023


Investing in CFDs involves a high degree of risk that you will lose your money due to the use of leverage, particularly in fast moving markets, where a relatively small movement in the price can lead to a proportionately larger movement in the value of your investment. This can result in loses that exceed the funds in your account. You should consider whether you understand how CFDs work and you should seek independent advice if necessary.

ADS Securities LLC (“ADSS”) is authorised and regulated by the Securities and Commodities Authority (“SCA”) in the United Arab Emirates as a trading broker for Over the Counter (“OTC”) Derivatives contracts and foreign exchange spot markets. ADSS is a limited liability company incorporated under United Arab Emirates law. The company is registered with the Department of Economic Development of Abu Dhabi (No. 1190047) and has its principal place of business at 8th Floor, CI Tower, Corniche Road, P.O. Box 93894, Abu Dhabi, United Arab Emirates.

The information presented is not directed at residents of any particular country outside the United Arab Emirates and is not intended for distribution to, or use by, any person in any country where the distribution or use is contrary to local law or regulation.

ADSS is an execution only service provider and does not provide advice. ADSS may publish general market commentary from time to time. Where it does, the material published does not constitute advice, or a solicitation, or a recommendation to a transaction in any financial instrument. ADSS accepts no responsibility for any use of the content presented and any consequences of that use. No representation or warranty is given as to the completeness of this information. Anyone acting on the information provided does so at their own risk.