What are CFDs?
Summary: What you should know before you start using Contracts for Difference.
If you’re used to trading stocks, CFD trading will feel completely familiar. In its most basic form, a CFD (Contract for Difference) is traded like a stock. You can buy a CFD then sell it with a profit when the price increase.
Due to its more flexible nature, the CFD also offers the possibility to go short, which means you can profit from both price increases and price decreases.
- What does it do?
When you trade CFDs, you trade the movements of underlying assets such as stocks. For example, a single-stock CFD on Apple follows the price movement of the Apple stock and is traded in the same way.
That means you can buy a CFD – go long – and you will profit from increases in the price of the Apple stock. On the other hand, you can sell a CFD, even if you don’t own any Apple shares, and profit if the share price decreases. That’s called going short.
In its essence, a CFD is a contract between two parties that either increases or decreases in value, depending on the price of the underlying asset. This means that if you buy a single-stock CFD, for example on Apple stock, you don’t buy the actual shares. You enter into a contract on the price development of the stock. If the price of Apple’s shares increases, the value of the contract increases correspondingly – you turn a profit. If Apple’s stock price decreases, the value of the contract decreases, and you make a negative return.
- What is it?
CFDs are financial derivatives. This means that the product or the contract is derived from an underlying asset. That can be stocks, indices such as the S&P 500 or FTSE 100, commodities such as gold or oil, currencies or a number of other assets.
Furthermore, CFDs are margin traded. Margin trading is a way for traders and investors to punch above their weight when entering positions. When buying shares, you typically will be able to invest equivalent to the amount of capital on your account. I.e. if your account balance is $10,000, you could buy shares worth $10,000.
When trading a margin product, you still need capital. However, margin trading means that your position uses leverage. If you take on a margin position, a certain amount of your investable capital is posted as collateral. Due to the margins, the position gets leveraged, meaning that you may only post $1,000 to take on a position of up to $5,000, for example.
- Covering in the market
When you’re trading stock CFDs with Saxo, you are trading with Direct Market Access. A bit simplified, that means that we take on the same position as you.
This ensures that we have complete alignment of interest with our clients: We profit when you profit, and we never take positions that go against our clients. We make money on single-stock CFDs from commissions and financing.
Commissions work exactly like on stocks. The financing cost is when you’re using margin for trading. When you’re trading on margin, where only a fraction of your capital is posted as collateral, you pay a small margin fee to the brokerage providing the additional liquidity – the extra bang for your buck.
You can find an overview of Saxo’s prices here.
- Be safe
While this means that any returns will be amplified compared to the posted amount of capital, losses may also be amplified. That is why we provide risk-management features such as stop-loss orders.
Due to their flexible nature, CFDs can, of course, be used for more aggressive trading. To the less aggressive trader and investor, CFDs can be used for mitigating risk to existing positions in times of volatility. So, make sure you know what you want to achieve, and stick to your strategy.
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