Authorised and Regulated:
Middle East & Africa
United Kingdom
Asia Pacific

The Truth About CFD Trading

  • CFD stands for contract for difference
  • CFD trading has some key attributes traders should know
CFD trading truth
Carl Paraskevas
Chief Economist
Jul 12, 2022, 7:44 AM
EURUSD
%
sell
buy

Let's Expose the Secrets

Before moving from a bank to a CFD broker, I dabbled in forex CFD trading a lot. Like many others I spoke to, however, I’ve found the answers to questions about CFD trading on the internet to be either contradictory or just blatantly wrong. As an active online trader myself, who has now worked at both a bank and brokerage, I will expose some of the CFD trading industries' worst kept secrets that have led to loads of confusion over the last couple of years.

What Is a CFD?

CFD stands for contract for difference, which is just an over-the-counter ("OTC") agreement with your online broker to pay the differences in the settlement price between the open and closing price of a trade. Just like options or futures, CFDs are a financial derivative, except they are, for the most part, not cleared centrally. You can trade CFDs referencing many different traditional asset classes like forex, equities, indices and commodities.

CFD trading

With CFD trading, instead of buying or selling a unit of forex or other type of asset, you agree to exchange the value of an instrument's price movement, by borrowing money to amplify any gains or losses. You can find an examples of how you profit on a CFD trade here. Brokers profit from the difference between the buying and selling price, even if they do not charge a dealing fee.

As financial derivative products, CFDs have been around for quite awhile. Wikipedia claims they were developed in London during the early 1990s as a type of equity swap traded on margin. Some of the most early adopters of CFDs were hedge funds in the early 1990s. I can’t vouch for the info from Wikipedia, but I do know their use in the UK did explode as trading CFDs avoided stamp duty and required a small margin. 

It didn't take long before the product caught on worldwide. CFDs are now available on a number of liquid instruments for individuals to trade online that offer leverage. Also, they are having a bit of a renaissance with institutions like hedge and investment funds. They are, however, not available to retail traders in certain jurisdictions, most notably in the United States.

Benefits of CFD Trading

CFDs have a number of attributes that offer a lot of benefits to online traders. Some of key attributes that make CFDs attractive are:

  • Multi-Directional: CFD trading give you the ability to trade the market in either direction: short or long.
  • Hedging: CFDs offer an easy way to hedge movements in the underlying referenced instrument, as well  other open CFD positions
  • Leverage: CFDs are leveraged contracts, meaning you are able to open position sizes in excess of your account balance.
  • Fractional Trading: CFD trading allows you to trade smaller minimum positions than you might otherwise be able.

Online Forex is CFD Trading

Thank god most online forex trading is CFD trading. Trading the spot forex market directly is not only expensive but it also can require a lot of starting capital. Some brokers do offer spot Forex market trading, typically with restricted leverage, but they usually require you to trade a full lot (100,000 units of the base currency) or if you are lucky a mini lot (10,000) units. If you’ve got an account with $500 with leverage of 50:1, you can’t even afford to buy into the game. 

CFD trading forex lot size

Plus the underlying trading process is complicated. Spot forex settles in T+2, requiring real money to move hands through various bank and payment networks. That inevitably adds to costs. Also, having a CFD broker typically doesn’t limit you to just trading forex. Because of all those factors, nine times out of ten, if you’ve traded forex online and you’re outside the US, you most likely were CFD trading. It’s cheaper, easier, and  more efficient than forex spot trading.

OTC Doesn't Make CFDs Bad

CFD trading is OTC, but that doesn't mean you aren’t getting the best pricing and liquidity. If the concept of OTC bothers you, then you shouldn’t be trading forex full stop. Spot and most of the derivative forex market is an over-the-counter business with no centralized exchange anyway. Getting the best pricing, liquidity, and availability, instead, relies largely on how the broker you use chooses to operate. If you have a market making broker, this means that the broker creates the market for you, rather than giving you access to the market. You rely solely on the broker to show and execute a price.

CFD trading market maker

Electronic communication network ("ECN") or direct market access ("DMA") brokers do the opposite. They aim to give you the best price and liquidity from a wide group of institutions. Their role is to execute your trades in the market rather than only show you pricing and liquidity in the markets they make. Using an ECN, or DMA broker, typically means you are trading in an environment that is undifferentiated from the underlying spot market. You are shown prices and liquidity from the very institutions that determine the spot forex market.

CFD trading ECN

CFD Trading Gives You Reach

Having a CFD trading account gives you more reach not less. Maybe you don’t want to trade just forex, but other types of financial instruments as well. Today there are CFD instruments for many different financial instruments, including futures. Rather than have multiple types of brokerage accounts, you can trade a number of different asset classes from a single account. In terms of risk  and account management, that can make the life of an online trader much easier. Just be aware of brokers that spread their net too wide in terms of product offering at the expense of decent trading conditions. 

CFD Swaps Exist For a Reason

CFDs do carry a swap rate cost. Traders are charged against the notional value of their positions held overnight. That’s because in order to open a CFD buy position on an equity share, for example, the CFD provider is effectively extending a synthetic loan of those shares to you, which comes at a cost. Always remember that with CFDs, even if you have a large account deposit you are always borrowing.

Forex traders often overlook this concept, as it gets more confusing when dealing with currency pairs. When I buy EUR/USD, I’m effectively borrowing USD and then simultaneously lending or depositing it until my trade ends. Borrowing the CFD comes at a cost but deposit or lending comes with a benefit. Overnight swap rates either charge or pay you depending on the difference between the currency you own and the currency you borrowed as part of the transaction. Many other derivatives work in a similar manner.

VARIANSE is a true ECN broker rather than a market maker. By trading with VARIANSE you get direct access to the full depth of liquidity in the market, ensuring you the best online trading conditions and execution. Twice awarded Best Broker for Trade Execution in 2021, VARIANSE is also globally regulated, meaning the firm is held to the highest standard when handling your funds and trades.

DISCLAIMER: All communication, messages, media and links distributed on this channel has been prepared by VARIANSE solely for information purposes without regard to any particular user’s investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but VARIANSE does not represent that it is accurate or complete. VARIANSE does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice. The information provided herein is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase or sales of any financial instrument. The information contained herein has no regard to the specific investment objects, the financial situation or particular needs of any particular recipient. Relevant and specific professional advice should always be obtained before making any investment decision. It is important to note that past performance is not indicative of future results. VARIANSE is a trading name of VDX Derivatives, authorised and regulated by the Financial Services Commission (FSC) of Mauritius. FSC license number C118023323. VARIANSE is also a trading name of VDX Limited and is authorised and regulated by the Financial Conduct Authority (FCA) in the United Kingdom. FCA register number 802012. This publication is not directed to residents of the United States and is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

Your global trading connection

We are an award-winning, internationally regulated, trusted and secure broker.

Regulated Globally

VARIANSE is authorised and trusted internationally. We have entities regulated by the FCA, FSC and LFSA.

Multi-Award Winning

VARIANSE has achieved consistent recognition from independent organisations and the financial community.

Premium Customer Support

Take comfort in an experienced team committed to providing you with rapid, efficient, and friendly support.

Tier-1 Banking Relationships

We safeguard your funds safely and securely in segregated ring-fenced client money custodian bank accounts with Barclays Bank.

RISK WARNING: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 58% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
VARIANSE is a trading name independently operated by the following regulated entities:
Copyright © 2015-2024. VARIANSE and VDX are registered trademarks. All trademarks, logos and brand names are the property of their respective owners.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 58% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
ELECTRONIC TRADING. ELEVATED