How to trade indices

Want to know how to trade an index using CFDs? This section breaks down every aspect of your first trade.

With, it’s possible to trade an index using CFDs, or contracts for difference. CFD trading allows you to take a position on the price of an instrument without owning the underlying asset. One of the most unique aspects of CFDs is the ability to profit from falling markets as well as rising ones.

The three key features of CFDs are:

  • CFDs are a derivative product
  • They’re leveraged
  • If you long or short, you can either profit or incur losses from rising and falling prices.

CFDs are a derivative product

The term ‘derivatives product’ simply means that when trading CFDs, you don’t actually own the underlying asset. You’re simply speculating on whether the price will rise or fall. When you trade a CFD, you are agreeing to exchange the difference in the price of a market from the moment the contract is opened, to the moment it’s closed.

Let’s say you want to purchase 10,000 shares of a NYSE-listed stock, like Walmart. Let’s say its stock price is $2.80, which means that the total investment would cost you $28,000, not including the commission or other fees your broker would charge for the transaction. In exchange for this, you receive a stock certificate, legal documentation that certifies ownership of shares. In other words, you have something physical to hold in your hands until you decide to sell, preferably for a profit.

With CFDs, however, you don’t own those Walmart shares. You’re simply speculating, and potentially profiting, from the same movements in stock price. And when you trade an index, you’re not purchasing the individual stock – you’re speculating on the overall price of the index, which is influenced by companies within it.

What Is Leverage in CFD Trading?

CFD leverage means you gain a much larger market exposure for a relatively small initial deposit. In other words, your return on your investment is significantly larger than in other forms of trading.

Let’s say you want to invest directly in the DAX, which is priced at 14,000. To buy one contract, need $14,000.

With CFD trading, however, you only need a small percentage of the total trade value to open the position and the same level of exposure. With, leverage on indices are available at 5%. This means that you would only need to deposit an initial $700 to trade the same amount.

If the DAX rises 5%, the value of the position is now $14,700. So with your deposit of just $700, this CFD trade has made a profit of $700. That’s a 100% return on your investment, compared to just a 5% return if the index was invested in without leverage.

The important thing to remember about leverage, however, is that while it can magnify your profits, your losses are also magnified in the same way. If prices were to move against you, you may be closed out of your position by a margin call or have to top up your funds to keep it open. Therefore, it’s important to understand how to manage your risk.

If the DAX falls 5% to $13,300, your initial deposit of $700 incurs a loss of the same amount. That’s a -100% loss on your investment, compared to just a -5% loss if the shares were bought physically.

What Is ‘Trading on Margin’ with CFDs?

Trading on margin is simply another term to describe leveraged trading, because the amount of money required to open and maintain a leveraged position is called the ‘margin’.

How Do CFDs Work?

To understand how CFDs work, it’s important to have a good grasp of the following concepts, and how they apply to CFD trading:

  • Spread and commission
  • Deal size
  • Duration

Spread and Commission

CFDs are quoted in two prices: the buy price and the sell price.

If you believe the price of an asset is going to rise, you go long or ‘buy’ and you’ll profit from every increase in price.

If you believe the price of an asset is going to fall, you go short or ‘sell’ and you’ll profit from every fall in price.

The spread is the difference between the buy price and the sell price. When placing a trade on the market, the spread is also the main cost of the position. The tighter the spread, the lower the cost of trading. The wider the spread, the higher its costs. You can also view the spread as the minimum distance the market has to move in your favour before you could start earning a profit.

Deal Size

Trading CFDs is more similar to traditional trading than other derivatives, such as spread bets or options. This is largely due to the fact that CFDs are traded in standardized contracts, or lots. The size of an individual lot depends on the underlying asset being traded, often mimicking how that asset is traded on the market.

Duration of the Trade

More often than not, CFD trades have no fixed expiry. A position can be closed simply by placing a trade in the opposite direction to the one that opened it.

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