Quick answer
CFD trading is a contract between a trader and broker to exchange the difference in an asset’s price between contract open and close. The trader does not own the underlying. Leverage allows large positions with small capital. CFDs work for forex, stocks, indices, crypto, and commodities, with retail leverage capped 1:30 to 1:2 under EU rules.
Contract For Difference (CFD) trading is essentially a smart financial bet on whether the price of an asset will go up or down. While many forms of traditional trading require you to buy and sell the asset itself, CFD frees you from this obligation. The advantage of doing this is that you can use leverage to hold much bigger positions with much capital.
Key Points
The contract is taken out between a trader and a broker, and both sides need to manage their risk exposure accordingly.
CFD trading is a form of speculation because you are betting on whether an asset will increase or decrease in price.
You can set up a CFD for any class of asset. Traders routinely create them for stocks, indices, forex, cryptocurrencies, and commodities.
Creating a CFD can be used to hedge an existing position and is, therefore, a highly strategic approach to risk management.
How CFD Trading Works
Elite traders and institutional investors routinely take a CFD approach to trading because it frees them from having to own the underlying asset. Rather than housing the asset and taking care of all the associated costs with having it on their balance sheet, they can focus on interpreting the market. Here are the basics of how it all works:
Anyone looking to enter a CFD trade will need to connect with a CFD trading broker who is willing to set up the contract with them.
Once the contract is in place, you can take a two-way approach to trading where you go long if you think the price will go up, and short if you think it will go down.
The main factor that will dictate the success or failure of a CFD trading strategy is the trader’s ability to read the market. Smart traders make their profits by opening and closing winning positions before the crowd.
There are additional advantages of CFD trading compared to traditional trading that may help you decide if it is the right approach for you.
CFD Trading Advantages
As well as not having to own the underlying asset, CFD trading allows you to take advantage of several potentially highly lucrative options:
Leverage and risk caps at Volity: CFD traders at Volity are executed by UBK Markets Ltd, a Cyprus Investment Firm authorised and regulated by CySEC under licence 186/12. Leverage is governed by ESMA product-intervention measures for retail clients in the EEA: 1:30 on major currency pairs, 1:20 on non-major currencies, major indices, and gold, 1:10 on other commodities and non-major equity indices, 1:5 on individual equities, and 1:2 on cryptoassets. Professional clients on request may access higher leverage subject to MiFID II suitability assessment. Negative balance protection applies to retail accounts.
Diversification: A CFD strategy can be used to trade in stocks, forex, and cryptocurrencies simultaneously. This will help to reduce the risk profile of the trader’s investments.
Hedging: Taking out a CFD can allow you to profit if an existing investment you hold elsewhere fails. This is a smart approach to strategic risk management routinely used by elite traders.
CFD traders are able to gain a deeper understanding of risk and exposure to the market, and they are not left holding a potentially worthless asset if the market crashes. That said, it is important to understand that highly leveraged positions can work in reverse and lead to large losses if improperly managed.
Ready to Enter the CFD Market?
Volity is a trusted platform for traders of all abilities who want to move into CFD markets. The complex nature of some of the more advanced CFDs is one of the reasons why we offer a comprehensive range of resources to bring you up to speed before you know it.
Taking a little time to read our guide on how to start CFD trading will show you how this potentially highly lucrative approach to trading works in more detail. We are always available to guide you through your options and help you make your first CFD trade when you feel ready.
