CFD trading is a unique form of online trading that allows you to invest in the price movements of a wide variety of financial assets in both directions—that means increases as well as decreases—however, instead of owning the item you’re trading (such as a barrel of oil or a gold bullion), you buy or sell contracts, hence the name Contracts For Difference. Each contract represents one unit of the financial instrument of your choice, and will differ: for example, in oil trading, one contract is equal to one barrel of oil; in share trading, one contract represents one share.
If you think the price of your chosen instrument will increase, you’d open a ‘Buy’ deal (or ‘Go long’) on a certain number of contracts for a set period of time and, if the price does, in fact, go up, you would collect a profit. If the price, however, goes down, you would lose your investment. Conversely, if you think the trading price of your chosen instrument will go down to begin with, you’d open a ‘Sell’ deal (or ‘Go short’) and collect a profit if the price does, indeed, decrease, whereas you’d lose your investment if the price goes up instead.
Now that you’ve got the basic gist of how CFD trading works, let’s take a closer look at the main types of instruments that are available to trade.
Many people choose shares as their instrument of choice because they’re already familiar with the company names. Many well-known brands such as Apple, Coca-Cola, McDonald’s, Microsoft, Amazon, Netflix, and Meta are publicly-traded companies and therefore, their share prices can be traded. What makes shares interesting to CFD traders is the many factors that can cause price fluctuations (a condition known as market volatility), which can include surprising as well as disappointing company performance announcements, economic situations such as inflation or recession, and global events such as pandemics, which can affect the public’s spending habits and therefore impact the companies from which they’d normally be expected to buy.
An index is a financial instrument that tracks the performance of a particular segment of the financial market, which serves two purposes: its price movements provide potential trading opportunities for those involved in CFD trading (as well as equal risk), and the overall performance of a given index can be a helpful indicator of relative economic health for investors. Some indices you may already be familiar with include the NASDAQ 100, which contains mainly tech-based companies, as well as the S&P 500, which is comprised of the top 500 largest companies listed on US-based stock exchanges.
Cryptocurrencies like Bitcoin, Ethereum and Litecoin are digital assets that are used as a store of wealth, a means of payment (like a currency), as well as a means of transaction, as cryptos both exist and are created on what’s known as the blockchain. The easiest way to explain the blockchain is as a decentralized (as in not regulated by any governing body, such as a central bank) public ledger that simultaneously records and files crypto transactions while creating new “coins.” The crypto trading market is known for being particularly volatile, as coin prices can change in a matter of hours, which certainly keeps the interest of those involved in CFD trading.
Think of an Exchange-Traded Fund as a “basket” of assets that are all somehow related to one another, and which is traded on the stock market. There are many types of ETFs available today, such as the Global Jets ETF, which gives investors exposure to the airline industry by including both airline operators and manufacturers, or Global Cannabis, which contains a number of cannabis-agriculture related companies, from growers to manufacturers of growing products to actual product makers. There are even ETFs that track market indices, such as the SPDR S&P 500 Trust, as well as crypto-related ETFs, like Global Blockchain. Overall, ETFs are a great way for CFD traders to diversify their portfolios without having to get too specific.
The commodity sector includes a number of raw materials that are bought and sold in units, such as oil companies like WTI Oil and Brent Oil, as well as agricultural commodities like coffee, cocoa, wheat and soybeans, energy commodities like natural gas and heating oil, and even precious metals like gold, silver and palladium. There are many different factors that can affect the price of commodities, so familiarity is essential before adding them to your CFD trading portfolio.
The foreign exchange market is the biggest in the world, with over $6 trillion in daily transactions. Also known as the forex market, it involves buying one currency with another in the form of a currency pair, and—like CFD trading—speculating on either a price increase or decrease. Some of the most popular forex pairs include EUR/USD, USD/JPY, and GBP/USD.
The bottom line
Before you start trading CFDs, it’s important to ensure you’re armed with a solid understanding of how the markets function and especially the unique factors which can affect the price of your chosen instruments. Like all forms of trading, CFD trading comes with risk, therefore it’s vital to make well thought-out, informed trading decisions. Regardless of how much experience you bring to the platform, take advantage of your broker’s educational resources before jumping in, and only choose instruments you’re familiar with.