Day trading with CFDs is a popular strategy. The leverage and cost of CFD trading make it a viable option for active traders and intra-day trading. This page contains an introductory guide, plus tips and strategy for using CFDs. We also list the best CFD brokers in 2020.

 

 

What is a CFD?

A CFD is a contract between two parties. They agree to pay the difference between the opening price and the closing price of a particular market or asset. So it is a way to speculate on price movement, without owning the actual asset.

The performance of the CFD reflects the underlying asset. Profit and loss are determined when that underlying asset value moves relative to the position of the opening price.

When you trade CFDs with a broker, you do not own the asset being traded. You are speculating on the price movement, up or down.

CFD Example

Let’s use an example. Suppose you choose a stock with an ask price of $25 and you open a CFD worth 100 shares.

If you bought shares the traditional way, the cost would be $2500. There may also be commission or trading costs.

However, a CFD broker only needs a margin of 5%. This will allow you to enter the same trade but with only $125. (The actual amount of leverage or margin will vary). This makes it an attractive hunting ground for the intraday trader. The risk and reward ratio is increased, making the short-term trades viable.

When you enter your CFD, the position will show a loss equal to the size of the spread. This means that if your broker’s spread is 5 cents, you need to appreciate the stock by at least 5 cents to break even.

CFD vs Stock

Using the above example: Let’s say the price of the underlying stock continues to rise and reaches a bid price of $26.00

If you own the shares, your share is now worth $2600. A nice profit – if the commission or trade is costed, the trader realized 100 dollars.

But with the underlying stock at $26.00, the CFD would show the same profit of $100 – but it needed much less to open, just $125. In terms of percentage, the CFD produced much larger profits. If the market had moved the other way, the losses relative to our investment would also have been greater – both risk and reward are increased.

Of course, there are other benefits to owning an asset rather than speculating on its price. We have also ignored commissions and spreads for clarity. But the above does illustrate the relative differences in the two investment methods.

Application

Since you are day trading, you are unlikely to hold any CFD positions overnight. Instead, you are likely to place a large number of CFD trades in one day. To maximize your returns, you want to focus on liquid volatile markets. For example, CFD trading in oil, bitcoin and forex are popular options.

CFD advantages

You may have already gained some benefits above from CFDs, but let’s break it down and add a few more.

  • Leverage – CFD leverage is much higher than traditional trading. You can get margin requirements up to 2%. The rate usually depends on the underlying asset. For example, stocks or volatile cryptocurrencies can reach up to 20%. Although low margin rates will allow you to take large positions with less capital, losses will also hit you harder.
  • Accessibility – With the best CFD brokers you can trade in all the major markets. With so many markets, this means that CFD trading hours are effective 24 hours a day. You just need to check the trading hours of your brokers first.
  • Costs – CFD trading systems have minimal costs. You will find that many brokers charge little or no fees to enter and exit trades. Instead, they make their money if you have to pay the spread. The size of the spread will depend on the volatility of the underlying asset. Note that this is usually a fixed distribution.
  • Less shorting rules – Some markets maintain rules that prevent you from going short at certain times. They may charge higher margin requirements for short, rather than going long. However, the CFD market generally does not have such rules as you do not own the underlying asset. This means no borrowing or shortfall charges.
  • Less Day Trading Requirements – Some markets require significant capital to start trading. This limits you to how many trades you can make, and in turn how much profit. An online CFD trader can set up an account with as little as $1,000 to $5,000.
  • Diversity – whatever shows your interest, you’re likely to find a CFD vehicle. You can trade with CFD FX, as well as using treasury, commodities, cryptocurrencies and CFDs on the index.

CFD Risks

Despite the many advantages, there are some disadvantages to CFDs that you should be aware of.

  • Regulation – The CFD industry is not thoroughly regulated. This means that choosing the right broker is increasingly important. You need to make sure that they are credible and in a strong financial position. Consult our brokerage page for more guidance.
  • Trading on Margin – While margin increases the profit potential, it also increases the risk. It is very easy to lose track of the total exposure you are using on margin. Open positions worth $2000 with margins of 5% means exposure to contracts worth $40,000. You are effectively borrowing $38,000 from your broker. If markets move against you, losses can exceed deposits. An awareness of the total exposure is very important.

How to start trading CFDs

One of the selling points of trading CFDs is how simple it is to get started. You only need to follow five simple steps.

1. Choose a market

There are thousands of individual markets to choose from, including currencies, commodities, plus interest rates and bonds. Try to choose a market that you have a good understanding of. This will help you respond to the market developments. Most online platforms and programs have a search function that makes this process quick and hassle-free.

2. Buy or sell

If you buy, you go long. If you sell, you go short. Bring up the trading ticket on your platform, and you can see the current price. The first price is the bid (sale price). The second price is the offer (purchase price).

The price of your CFD is based on the price of the underlying instrument. If you have reason to believe that the market will increase, you should buy it. If you believe it will go down, sell.

3. Trade size

You now need to select the size of CFDs you want to trade. With a CFD you control the size of your investment. Although the price of the underlying asset will fluctuate, you decide how much to invest. However, brokers will have minimum requirements – or more simply, a minimum amount required to open the trade. This will vary asset by asset. However, this will always be made clear, as will the total value (or your exposure) of the trade.

Volatile assets like cryptocurrency usually have higher margin requirements. So a position with exposure to Bitcoin worth $2000 may require, for example, a margin of $1000. ‘AWell-traded stock may only have a margin of 5%. So, a $2000 position on Facebook might only require $100 of account funds.

4. Add Stops & Limits at

This will help you secure profits and limit any losses. Most CFD strategies for beginners and experienced traders employ the use of stop losses and/or limit orders. This ties into your risk management strategy. Once you have defined your risk tolerance, you can place a stop loss to automatically close the trade once the market reaches a predetermined level. This will help you minimize losses and keep your accounts in the black – so you can fight another day in subsequent trades.

A limit order will instruct your platform to close a trade at a price that is better than the current market level. If you choose a trading bot, they will use pre-programmed instructions to enter and exit trades in accordance with your trading plan. It is ideal for closing trades near resistance levels without constantly monitoring all positions.

5. Monitor & close

Once you place your trade and stop or loss limits, your profits will move along with the market price. You can view the market price in real time and you can add or close new trades. This can be done on most online platforms or through apps.

If your stop loss or limit order is not activated, you can close it yourself. Select ‘lock position’ in the position window. You will be able to see your profit or loss in your account almost immediately.

 

 

Strategies

Choosing the right market is a hurdle, but without an effective strategy, your profits will be few and far between. You need to find a strategy that compliments your trading style. This means that it plays to your strengths, such as technical analysis. It also means that it fits your risk tolerance and financial situation.

Two popular and successful CFD trading strategies and tips are outlined below.

Break strategy

It simply requires that you identify an important price level for a particular security. If the price reaches your key level, you buy or sell, depending on the trend. The most important thing to remember with the breakout trade is to avoid trades when the market is not giving clear signals.

If you can’t quite see in which direction the general trend is moving, you may miss it. This is where detailed technical analysis can help. Use charts to identify patterns that give you the best chance of telling you where the trend is headed.

Contrarian strategy

It’s all about timing. Your plan is based on the knowledge that trends don’t last forever. If the price of a stock is falling, you identify a point where you believe it is near the end of the trend. Then you enter a buy position in anticipation of the trend turning in the other direction.

You can follow exactly the same procedure if the price goes up. You can short a stock that is increasing in price if you think a sharp change is imminent. Both Wave Theory and a range of analytical tools will help you identify when these shifts will occur.

Consult our strategy page for further guidance.

Tips for CFD trading

Consider these tips from top traders if you’re looking to improve your profits. Learn from their mistakes and hopefully you won’t end up in the same expensive pitfalls.

Control your leverage

Leverage is your greatest asset if you have made the right trade. The temptation to increase your position if you win is hard to resist. However, there is always a loss on the horizon.

You don’t want to be the trader who turns a small account into a giant account, only to end up square. So, you have to be smart. No one wants margin calls and the stress that comes with big losses. As Paul Tudor Jones famously said, ‘Don’t focus on making money, focus on protecting what you have.’

Having said that, start small first. Keep your exposure relatively low compared to your capital. It’s a good idea not to leverage more than three times your account size, especially in the beginning.

As your capital grows and your fold in your strategy radiates, you can slowly increase your leverage.

Keep a journal

A bit like a diary, but outline the descriptions of your pressure point for entry and exit points, price, size of the position and so on. This will be your Bible as you look back and identify mistakes. CFD trading journals are often overlooked, but using them can be invaluable.

Background is a powerful force, don’t waste it. You will be able to identify patterns, reflect on your trading emotions and streamline strategies. A thorough trading journal should include the following:

  • The tool
  • The time you entered and exited the trade
  • Reasons for the trade, technical, news based, etc.
  • Whether it was a profit or a loss
  • A review of your trading performance (including whether you followed your trading rules)
  • What you learned from trading

This may sound time-consuming, but it will allow you to constantly revise and improve. You’ll make smarter and faster decisions, while those out there are still scratching their heads wondering what they’ve been doing wrong for the past few weeks.

Use stops

Used correctly, you can minimize your losses and keep you in the game. Every trade you make needs a crystal clear CFD stop. This is because emotions will inevitably be high and it can be hard to resist the temptation to hold on that little bit longer. As William O’Neil rightly observes, ‘the biggest mistake most investors make is to run losses.’

So define a CFD stop outside market hours and stick to it religiously. It will also help you anticipate your maximum possible loss. You can then use the time you would be fighting an internal battle to research and prepare for the next trade.

Demo Accounts

When you’ve done your research and finally have the capital to start trading, it can be hard to stop yourself from jumping in head first. However, the affiliated day trader will first test his strategy with a demo account.Many brokers offer these practice accounts. They are funded with simulated money, making them the ideal place to make mistakes before your real money is on track. Not only can you test your strategy and get familiar with CFD trading markets, but it is also an effective way to try out your broker’s trading platform. You can make sure it has all the charting and analysis tools your trading plan needs.

If you are comfortable and seeing consistent results on your demo account, you should upgrade to a live account.

Education

Nobody likes to hear it, but school isn’t over. The best traders will never stop learning. You need to keep abreast of the market developments, while practicing and perfecting new CFD trading strategies. Learning from successful traders will also help. To be able to do all this, you need to use different resources. To name just a few:

  • Blogs
  • courses
  • forums
  • videos
  • PDFs
  • Books and books
  • podcasts
  • Online guides

Regional differences

Taxes

Although you can trade CFDs all over the world, you can have an expensive wrench in the works where you are based and the market in which you trade. CFD trading in the US will be different than in the UK, Australia, India, South Africa and Singapore.

This is mainly due to taxes. Different countries view CFDs differently. Some consider them a form of gambling activities and therefore tax free. Some countries consider them taxable like any other form of income.

In addition to the tax implications in the UK, for example, CFD trading will fall under the requirements of capital gains tax. Although you get an annual exemption of £10,100, any gains over this will be taxed. This means that you need to keep a detailed record of transactions so that you can make accurate calculations at the end of the tax year.

So before you start trading, find out if you will pay personal income tax, business tax, capital gains tax, or if you have no tax. Once you know what type of tax liability you face, you can factor it into your money management strategy.

Final Word

CFDs for day trading can be relatively less risky than other instruments. That said, designing and implementing a consistently profitable strategy will still be challenging. If you want to be a successful CFD trader, you need to take advantage of the educational resources above and follow the tips. As successful trader Alex Hahn pointed out: If you master your thinking and emotions, nothing can stop you. So, the ball is now in your half of the court, go turn it into gold.