An introduction to CFD stocks and how they work

David Banks
Authored by David Banks
Posted: Tuesday, August 31, 2021 - 10:03

Stocks and shares are some of the most popular traded assets amongst investors, as the market experiences a high level of liquidity, and there are numerous ways to gain exposure. One of these being contracts for difference (CFD). There are both advantages and disadvantages to CFD stock trading, and through this type of trading, you can gain exposure to a larger portion of the market. As with any investment, you should conduct extensive research before you part with your capital. With that in mind, in this article, we’ll explain further about CFD stock trading and how it works.

What are contracts for difference?

The first place to start is to answer the question: what is CFD trading? CFD stands for contract for difference, and is a financial derivative, as the price is derived from the price of the fundamental asset. The contract, also known as a unit, takes place between two parties, typically the buyer (an investor) and the seller (a broker). The profit or loss is calculated from the difference between the initial price of entering the contract and the final price when the contract is exited.

The main difference between CFD trading and that of traditional stock trading, is that you do not own the underlying asset, which provides the opportunity to speculate on the price movement on the stocks in questions, and to take a position on both a rising or falling market. If you expect the price of the particular stock to rise, then you would buy a certain number of units. However, you would sell them if you expect the price to fall. At all times, the price of the CFD mirrors that of the underlying stock market.

How to: CFD stock trading

Firstly, you should conduct research on the market you wish to enter, as well as the company and stocks you wish to speculate on. From there, you should choose a reputable and regulated contracts for difference trading platform, to ensure that you are offered the best leverage ratios and that all prices are truly transparent, and reflective of the underlying stock market.

You can then create an account and deposit your capital, and if you so wish, take advantage of a demo account that can provide an avenue for you to try and test your stock trading strategies. You can then move on to real money and predict the market movement of the shares you wish to invest in, and act accordingly, opening or closing a number of CFD units.

Through a CFD trading platform, you can purchase as many stock units as you like, and can examine markets from across the globe, including trader favourites and big names, such as Amazon, Facebook, Alibaba and Netflix.

The benefits and disadvantages of CFD stock trading

Unlike traditional stock trading, when speculating on the market, you do not own the underlying share of the company in question. This means that you cannot benefit from any potential voting rights that comes with owning a share in a company, or profit from the dividend pay-outs.

However, with CFD stock trading you can utilise leverage, which means you gain access to a larger portion of the market, and predict the price movements of a share(s) without needing a large initial amount of capital. Furthermore, the leverage ratios found on a contracts for difference trading platform are usually higher than that of traditional trading, which can lead to a greater potential for profit. Using leverage when trading does also mean that any losses incurred will also be magnified.

Finally, when it comes to using a CFD trading platform, you’ll have the opportunity to access the major global markets and shares, all in one single trading environment. It can be beneficial to both short-term and long-term investments, and you can have the chance to build, grow and diversify your portfolio with CFD share trading.