What is CFD trading? A beginner's guide

This post was originally published by Deriv on 10 March 2022.

Understanding CFD trading

CFD trading is a popular form of trading where a broker and a trader agree to exchange the price difference of an underlying asset between the trade's open and close times. This agreement is called a contract for difference (CFD).

Trading CFDs allows you to trade on the price movement of any financial market – stocks and stock indices, commodities, forex, cryptocurrencies, and derived indices, without owning the underlying asset.

How does CFD trading work? 

Let’s say you think the price of an asset is going to rise. You can open your trade with a buy order for this asset, then place a sell order when the price is higher and gain the difference. This type of CFD trading is called going long.

It works a little differently when you think the price of an asset is going to go down. In this case, you can open a trade with a sell order, then place a buy order when the price is lower and gain the difference. This type of CFD trading is called going short.

It may sound a little odd to open your trade with a sell order when you don’t actually have anything to sell. But when trading CFDs, you buy a contract only and not the underlying asset. So, a sell order, in this case, means that you predict the downward price movement, but you don’t actually sell an asset.

The difference between the price when you open your position and the price when you close it will be your profit. The more the market moves in the anticipated direction, the more profit you make. However, if the market moves in the opposite direction from your prediction, this price difference will become your loss.

What is the margin in CFD trading?

When you buy a CFD, you don't have to pay the full value of the position. In fact, you make a refundable deposit to cover only a fraction of the trade value, and we cover the rest of the trade. This amount is also known as the margin and will be returned to your account should the trade be successful.

This practice is called trading on margin or leveraged trading. It allows traders to open bigger positions with smaller initial capital and amplify the potential profit. However, it’s important to remember that potential loss is also multiplied.

Let’s see how it works. For example, let’s assume one stock of Apple currently costs 10 USD. You think the price will go up and buy 100 CFDs on Apple stock. The broker you are trading with has a set margin rate of 10%. It means you only need to pay 10% of the total value of the trade to open it – this is your position margin.

Here is how it’s calculated:

You can also use our margin calculator to help you check your math.

If your prediction is correct and the price of one Apple stock moves up to 15 USD, the new total value of your trade will be:

You may decide to close your trade at this point and take your profit. In this case, your initial trade amount was only 100 USD, but your profit will be:

However, keep in mind that if your prediction is incorrect and the Apple stock price drops to 5 USD, your loss will also be 500 USD, which is also more than your initial stake. 

That’s why learning CFD trading basics and honing your skills is crucial before jumping into real-world trading. Want to see how margin works in practice? Try our risk-free Deriv MT5 or Deriv X demo account, pre-loaded with virtual 10,000 USD and practice trading CFDs on margin.