The ins and outs of stock CFDs: What you need to know before trading CFDs
Stock or equity CFDs are trading instruments that allow you to speculate on the direction a particular company’s shares will move. We explain exactly how they work.
How do I trade stock CFDs?
A contract for difference (CFD) is a deal made between a trader and a stockbroker that begins with the trader taking a view about which way a particular stock will move. At any given time, a buy price will be advertised alongside a sell price. The trader chooses to buy if they believe a stock is entering a bullish phase; and will sell if they believe the stock is about to fall.
One of the main concepts to bear in mind is that you are not purchasing or selling actual stock in your targeted company when getting involved in a CFD. The idea is to turn a profit by correctly forecasting the direction of a stock, and then closing the contract with your broker in a timely fashion. Obviously, if the stock moves in the opposite direction to your expectations, you will incur a loss on the trade.
CFD trading v share dealing: which is best for me?
Stock CFDs and equity dealing are two methods to speculate on financial markets.
CFDs might be for you if you want:
- To trade on leverage
- The option to go short as well as long
Share dealing might be for you if you:
- Wish to commit to the full value of the position up front
- Want to take ownership of the asset
What is going long or going short?
When you trade stock CFDs, you choose to go long (buy) or go short (sell). Shorting opens a position that will profit if the underlying asset price falls. It can be a useful method of targeting returns in bearish conditions.
Whether you’re bullish or bearish, the process involved is the same. You make your market direction prediction and place the trade through our platform with just a couple of clicks. The process is extremely straightforward.
What kind of people trade CFDs?
CFDs are often popular among active traders who enjoy having multiple positions and who are prepared to closely monitor those positions. Investors who buy stocks through traditional methods are frequently happy to hold assets for months or years, looking for longer-term returns. In contrast, some CFD traders might try to realize profits within a single day.
That doesn’t mean you can’t also use CFDs to target longer-term returns: some traders will keep positions going for weeks or even months.
CFDs come with three key advantages over investing: leverage, going short and the range of available markets.
How does leverage work in stock CFDs?
You may or may not be aware of how leverage works in trading. It is, for example, a significant feature of forex trading. However, it is also a key feature in stock CFDs.
The difference is that minimum margin requirements on stock CFDs tend to be greater. Typically, for Canadian dollar-based accounts, they are set at 30%, but for some stocks the MMR is 40% or 50%. The full list is available online for you to check at your convenience.
If you are trading a CFD with a 40% MMR, you could benefit from leverage at a ratio of 2.5:1. This is calculated by dividing 100 by 40. In practice, it means that to trade a position of $10,000 in a particular stock, you would require a minimum of $4,000 to enter the initial trade.
Remember, you always earn 100% of a transaction’s gains, but are also liable to pay 100% of the losses. Use risk management tools – such as stop-loss orders, take profits and guaranteed stops – to build in safeguards.
Whenever you trade with leverage, it is important you understand all the inherent risks involved. Leveraged trading increases your opportunity to profit but also increases risk. It’s essential that traders maintain the indicated margin requirements for all open positions in order to avoid any unexpected liquidation of trading positions.
What stocks can I trade?
When you trade stock CFDs through FOREX.com, you have access to more than 220 of the most popular UK and US company stocks. You will trade on variable spreads that are clearly advertised – the buy price is a little higher than the sell price – and commissions are as low as 0.1%.
Picking from a wide range of stocks allows you to create a customized portfolio, but remember to keep across all your positions and be aware of all the different trading hours. For example, London is five hours ahead of New York, which mirrors Eastern Time Zone.
Trading stock CFDs: An example
IBM is trading at a sell/buy price of $150/$155.
You are keen to buy IBM stock CFDs because you think its price will rise and want to secure a position of 10 units, with a value of $1,550.
At FOREX.com, the stock CFD for IBM has a minimum required margin of 30% so you must deposit 30% of the position’s value as collateral, $465.
Your prediction proves to be right. IBM stock rises during the course of the next week and the sell/buy price has moved to $180/$187 so you close your position by selling at 180 (the new sell price).
The price has moved 25 points in your favour. Multiplied by your position’s size (10 units) your profit is $250, less any commission.
How to start CFD trading with FOREX.com
- If you are aware of the risks involved, and are ready to commit your funds straight away, open an account.
- Alternatively, consider opening a free demo account, valid for 90 days, to explore a range of positions and watch the markets move with a virtual $50,000.
- Find the stock you are looking for, then buy (go long) if you think the price will rise or sell (go short) if you believe it will fall.
- Having executed your trade, monitor your open position and consider adding a stop-loss and a take-profit order.
- If your trade does not automatically close due to a stop or take-profit order getting hit, you can manually exit your position whenever you wish.
Trading with CFDs involves significant risk of loss and is not suitable for all traders.