How does trading in CFDs work?

Trading CFDs looks fairly complicated at first, but once you understand the basic principles and have tried a few trades, it’s even simpler than traditional trading at an investment bank. In this article, we look at how trading CFDs works.

CFD: buying stocks

contract for differenceCFD stands for Contract for Difference and it can’t be compared to purchasing stocks or currencies with a normal trading bank account. With CFD trading, you sign a contract with a broker to buy a certain amount of stocks (long, you earn when the price goes up) or to sell a certain amount of stock (short, you earn money when the price goes down).

The broker covers this risk by hedging the position (opening an opposite position) that the broker closes as soon as you have closed yours. This way, the broker rarely loses on any position, and they earn a little money by calculating the spread. In our article about the costs of trading CFDs, we discuss this strategy further.

A huge benefit of trading CFDs is that you are not the physical owner of the stock. The price difference determines if you’ve made a profit or loss and, because you aren’t the owner of any stock, you only pay a small transaction fee.

Positions

The broker can form contracts for known financial instruments such as stocks, commodities and index funds. There is no expiration date, meaning the position only closes when the user gives the order to do so. The difference between the buy and sell price determines whether you made or lost money. This article about profits and losses while trading CFDs, goes into this in more detail.

Tip: This article is part of the course ‘Trading CFDs: learn how to trade!’

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