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10 questions on stock CFDs
We took note of the most common questions we hear about stock CFDs, and present here a list of detailed answers to help you feel comfortable and confident about your trades.
- What is a CFD?
- Why trade CFDs rather than just buying stocks?
- How does leverage work in stock CFDs?
- Which stocks can I trade?
- What hours can I trade CFDs
- What are the risks of CFD trading?
- How is CFD trading regulated in Canada?
- What is the profile of a successful CFD trader?
- How exactly do I lock in a profit on a CFD?
- Can I try trading CFDs risk-free?
What is a CFD?
A CFD (contract for difference) is a deal made between a trader and a stockbroker that begins with the trader taking a view about which way a particular stock will move. If the trader feels strongly that the stock will take off, he or she will buy it. Conversely, the trader would sell if he or she believes the price is on the verge of a tumble.
The most important thing to remember when dealing in CFDs is that you don’t actually own the stock. You are never purchasing or selling stocks in your targeted company. Making a profit from trading in CFDs stems from correctly forecasting the direction a stock takes and closing the contract with your broker while the price is still in your favour.
CFDs can also be traded in commodities and indices, but this article looks at the specifics around trading equities (or stocks).
Why trade CFDs rather than just buying stocks?
CFD trading is beneficial for those who are seeking to benefit from leverage, a feature that is not available for standard purchases and sales of stocks. Although leverage can greatly increase your chances for profit, it can also magnify your losses. Leverage enables you to open positions without paying for their total value. Instead, you pay a deposit known as your margin.
You have this option because you're only speculating on the price movements of markets, not buying them outright. This is the same principle that is common in forex trading.
Another reason traders prefer CFDs is the ability to go long (buy) or short (sell). For example, if you short a stock and the price tanks, the result means big profits for you. To successfully short a market on our platforms you simply need to press the SELL button and wait for the market to turn downwards. No previous ownership of the asset is required.
How does leverage work in stock CFDs?
You may or may not be aware of how leverage works in trading. It is, for example, a significant feature of forex trading. And it is also a key feature in stock CFDs.
The difference is that minimum margin requirements on stock CFDs tend to be greater. Typically, for Canadian dollar-based accounts, they are set at 30%, but for some stocks the margin requirement is 40% or 50%. The full list is available online for you to check at your convenience.
If you are trading a CFD with a 40% margin requirement, you could benefit from leverage at a ratio of 2.5:1. This is calculated by dividing 100 by 40. In practice, it means that to trade a position of $10,000 in a particular stock, you would require a minimum of $4,000 to enter the initial trade.
Remember, you always earn 100% of a transaction’s gains, but are also liable to pay 100% of the losses. Use risk management tools – such as stop-loss orders and take profits – to build in safeguards.
Whenever you trade with leverage, it is important you understand all the inherent risks involved. Leveraged trading increases your opportunity to profit but also increases risk. It’s essential that traders maintain the indicated margin requirements for all open positions in order to avoid any unexpected liquidation of trading positions.
Which stocks can I trade?
When you trade stock CFDs through FOREX.com, you have access to over 2,500 stocks from the most popular countries worldwide. You can also trade whole indices (baskets of stocks like the FTSE 100 in the UK or the S&P 500 in the US), or commodities like oil or gold.
You will trade on variable spreads that are clearly advertised – the buy price is a little higher than the sell price – and commissions are as low as 0.1%.
Picking from a wide range of stocks allows you to create a customized portfolio, but remember to keep across all your positions and be aware of all the different trading hours. For example, London is five hours ahead of New York, which mirrors Eastern Time Zone.
What hours can I trade CFDs?
At FOREX.com, stock CFD market hours duplicate the hours of the actual markets in which the relevant stocks are traded.
Essentially, this means 9.30am to 4pm on week days for stocks traded on US indices and 3am to 12pm for stocks traded in the UK.
Trades cannot be placed outside these hours and positions that remain open overnight will next be affected by the following day’s initial trading.
Remember that “gapping” can occur - in other words, the market can open above or below the previous day’s close with no market activity in between. In these circumstances, stop losses can protect some of your trading margin.
What are the risks of CFD trading?
Not unlike FX trading, trading CFDs comes with its own inherent, potentially significant risk.
First, the trader must know about the spread. Paying the spread on entries and exits minimizes the potential to profit from small moves. The spread also decreases winning trades by a small amount and will increase losses by a small amount.
CFD trading is fast-paced and presents the possibility of a trader having to cover swift declines in his or her position, and potentially having your position closed if the price swings far enough in the wrong direction. In this scenario, you will have to cover the losses no matter what subsequently happens with the price.
How is CFD trading regulated in Canada?
CFD trading in Canada is legal but heavily regulated. All brokers operating in Canada or opening accounts for Canadian citizens must conform to the regulations set out by the Canadian Investment Regulatory Organization (CIRO). CIRO operates under recognition orders from provincial and territorial securities commissions that make up the Canadian Securities Administrators (CSA). CIRO regulated firms also participate in the Canadian Investor Protection Fund (CIFP), which protects individual investors in the event that an investment firm should go bankrupt.
Ultimately, you can take comfort knowing that your endeavours trading on the Canadian CFD market are regulated.
What is the profile of a successful CFD trader?
Two key qualities found in most successful CFD traders are experience and attentiveness.
Having a wealth of trading experience benefits you greatly when diving into CFD trading. This way, the typical ebbs and flows of market movements will not disorient you, and you can focus on executing your strategy and targeting stocks with confidence based on research.
CFD traders should also be prepared to monitor their positions closely. While longer-term profits are available with CFD trading, short-term (even same-day) returns are also. This means that, in contrast to traditional stock investing, shifts in price throughout a single day are much more crucial and require sharp tracking to ensure the best chance for a positive return.
How exactly do I lock in a profit on a CFD?
Just like any other execution you make on our trading platform, simply close your position while the price of your stock is still in your favor. This process doesn’t change with the trade being in a CFD instead of an FX pair or commodity.
Just keep in mind that many CFD traders typically open and close several positions in a single day, so it is more than sensible to be looking for short-term gains as opposed to the longer-term investment plan of traditional share purchasing (and selling).
Can I try trading CFDs risk-free?
The short answer? Absolutely.
If you want to see how CFD trading works in practice, you can open a demo account. Demo accounts give you access to the price movements of the same markets that funded account-holders are actively trading. But you get that access with virtual funds. That means you can experience how trading works with none of the risk.
A FOREX.com demo account, for example, gives you $50,000 in virtual funds to trade on the live prices of a huge range of markets. You'll get full, unlimited access to all the features and tools of our platform for 90 days, and there’s no obligation to convert to a funded account afterwards.
Alternatively, you could go straight to live trading. If you want to start trading CFDs immediately, follow these four steps:
- Open a live trading account
- Once your account is approved, add some funds
- Log in to the platform
- Find your first trade
Trading with CFDs involves significant risk of loss and is not suitable for all traders.
