CFD trading explained

Our comprehensive guide tells you all you need to know about CFD trading, how it works and its advantages and disadvantages.

CFD trading explained with examples

Margin trading

Spread and commission

With CFD trading, you’re always offered two prices based on the value of the underlying instrument: the buy (bid) price and the sell (offer) price. The price to buy will always be higher than the current underlying value and the sell price will always be lower. The difference between these prices is called the spread. At Capital.com, we do not charge commission on any CFD trades made with us.

Now imagine that the price of gold increases as expected, the profit from from this trade is illustrated below.

Contract size

The contract size of a CFD depends on the underlying asset. For example, a share CFD implies 1 share. So, if you intend to trade 1,000 shares of Tesla using contracts for difference, you should buy 1,000 CFDs. Commodities are far more interesting from this perspective. The contract size of gold is a troy ounce. Soybean is traded in bushels. Coffee is traded in pounds, and so on.

Going long and short

When you open a CFD position, you select the number of contracts you would like to trade (buy or sell) and your profit will rise in line with each point the market moves in your favour. If you think the price of an asset will appreciate, then you would open a long (buy) position and profit if the market moves in line with your expectations. Conversely, if you think the price of an asset will depreciate, then you would open a short (sell) position and profit if the market moves in line with your expectations.

Going long with CFDs

Going short with CFDs

Risk management: stops and limits

You can set up limit orders to automatically close out a position at a given profit level, meaning you don’t have to spend time watching the price fluctuate. Limit orders also reduce the likelihood of holding onto a winning trade for too long, as emotion can take over and blind you of your initial expectations. Similarly you can place stop-losses to restrict your potential losses. A stop-loss is the point at which a position is automatically closed out if the price of the security drops below the trader’s entry point. Stops and limits are crucial risk management tools and are strongly advised.

Setting stop-losses is extremely good practice for any trader, even for a seasoned one (and that’s not speaking of beginners). You may question the importance of stop-losses when you don’t have open positions. But once you feel the emotional weight of a falling market, you will understand how painful it is to lose your money in a matter of seconds. The market is volatile, and you should accept that; it will help make you a smarter trader.

Duration

One of the major points to remember when trading CFDs is that they do not have an expiration date. A trade is closed only when placed in the opposite direction – it is as simple as that. For example, you can close a buy trade on 100 CFDs on silver only by selling these CFDs.

Profit and loss

Profit and loss are easily calculated with a simple formula. You just multiply the number of contracts you hold by the difference in price.

After you’ve considered extra costs like overnight fees, then you will have the ‘take home’ value of your wins or losses. Capital.com only charges overnight fees on the leveraged portion of the trade – not the total trade size.

Your profit to loss ratio, often abbreviated to P&L, can be calculated using the following formula:

P&L = number of CFDs x (closing price – opening price)