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Understanding CFD Trading Methods and Benefits

CFDs are popular financial instruments that are indispensable to a trader’s port. However, it is not easy for those who are new to trading to understand the pros and cons of CFD trading and investing.

For this reason, Deriv has created the CFD Guide to answer the fundamental question of ‘what is CFD trading’. This guide will give you all the information you need to look at CFD trading from a balanced perspective, determine if CFD is the right product for you, and tailor it to your trading style.

Deriv has a variety of trading accounts for CFD trading. This account is suitable for beginners and advanced traders alike, offering a variety of competitive leverage and margin rates.

Choosing the right broker for CFD trading is important. Traders should choose a regulated, secure, experienced and award-winning broker like Deriv.

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What is CFD?

CFD is an acronym for contract for difference and is a type of trading product that investors often encounter when entering the financial market. The broker offers CFDs along with other instruments such as Forex, Commodities, Spot Metals and more. However, unlike other products, CFDs are derivatives. In other words, it is a product whose price is determined according to the movement of the underlying asset.

When a trader trades CFDs, it means they are entering into an agreement with the broker. A trader (“buyer”) and a broker (“seller”) agree to a contract to profit from changes in the price of an asset in market conditions. For traders to profit from trading financial instruments, it is important to know the main difference between traditional trading and CFDs.

Trading CFDs allows you to take advantage of price fluctuations without having to hold the actual underlying asset. Because CFD traders do not hold the underlying asset, they avoid the disadvantages and costs of traditional trading methods.

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How does CFD trading work?

So what does a contract do? Basically, the profit or loss is calculated as the difference between the price at the time of signing the contract and at the time of settlement. In other words, the broker (“Seller”) who is the party to the contract pays the difference between the start and end of the contract. In the event of a loss, the trader (the “buyer”) pays the broker the difference.

The profit-and-loss method is to multiply the difference between the price at the time of entry and the price at the time of exit by the CFD quantity. CFDs are offered across a wide range of instruments. In fact, with Deriv, CFD traders can choose CFDs on stocks, indices, commodities and cryptocurrencies, taking advantage of the same advantages as directly trading those instruments. Detailed information on the individual CFDs offered can be found on Deriv’s Contract Details page .

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3 things to do to start trading CFDs

For experienced brokers, trading CFDs is a simple process. As soon as you open a trading account, you can start trading by selecting a trading product. Also, the demo account allows you to try out CFD trading to see if it’s right for you before you actually start trading.

1. Select transaction product

The choice of underlying assets such as stock CFDs, cryptocurrency CFDs, index CFDs, and commodity CFDs is important. Confused about which one to choose? Check out Deriv’s Forex Trading and Forex Beginner’s Guide for an overview of the underlying assets you can choose from. In addition, you can find out which stocks are mentioned in the current news through recent market analysis reports and videos.

If you go to the broker’s contract details page, you’ll find a detailed breakdown of each CFD, where you can find information on commodity leverage and transaction costs.

2. Position selection

Once you have decided which CFDs to trade, it is time to decide on your position. Simply put, you can open a long position (buy) when you think the price will go up and a short position (sell) when you think the price will go down.

A variety of indicators, charts and signals are available to determine which positions to open. For more information on popular strategies and indicators, you can refer to our Forex Strategy Guide.

Next, select the size of the position to open. The value of 1 unit of CFD to be traded depends on the stock, so you need to calculate the optimal CFD quantity for your trading strategy.

3. Choose your platform

CFDs can be traded on the most popular trading platforms: MetaTrader 4 (MT4) and MetaTrader 5 (MT5). The platform has all the tools you need to trade CFDs, including over 50 indicators and charting tools. You can also trade on the mobile app, so you can see your profit and loss situation in real time on the go.

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CFD trading example

Now that we have explained the basic CFD P&L method (the difference between the opening price and the closing price multiplied by the CFD quantity), let’s see how we can apply this calculation in practice.

Example Buy 1 lot of #GE (General Electric)

If you think General Electric stock is going up, you can buy #GE CFDs on Deriv. The opening price is 31.36, and if you buy 1 lot at this price, your commitment is $3,136.

To know the P&L amount for that position, you need to calculate the difference between the opening price and the closing price. For example, if the stock price at which General Electric was liquidated was 31.94, the difference would be 0.58. Multiply this difference by the CFD quantity to calculate the profit or loss on a particular trade.

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Know the CFD Margin and Leverage

Margin and leverage are important considerations when trading CFDs. One of the main advantages of trading CFDs is that you can trade for only a fraction of the total traded amount. Trading CFDs on Deriv only requires a minimum margin of 3%. Deriv’s Margin Calculator is a useful tool when managing your margin on your Deriv Standard account.

CFDs are more leveraged than traditional trading methods. Traders can earn much larger returns by using only a fraction of their funds. However, it is important to remember that leverage can increase losses as well as gains. Traders can use the Deriv Leverage and Margin Calculator to calculate the margin required for each Deriv account type.

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CFD trading platform

MT4 and MT5 have the latest charts and tools to help you implement your CFD trading strategy. Deriv allows you to trade CFDs on stocks, indices, commodities and cryptocurrencies using the most popular platforms.

MetaTrader is equipped with the latest tools to provide a smooth and convenient CFD trading experience. Discover how the latest features can improve market understanding and analytics.

You can also trade from your mobile device by installing Deriv Trader. This innovative investment app allows you to trade from anywhere with your smartphone in the palm of your hand. Download now to quickly manage your trades, view your trading accounts, and check real-time exchange rates.

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CFD trading tools

EA
EA (Expert Advisor) is a program that uses a trading algorithm. The program responds to parameters set by the trader and issues trade orders on behalf of the trader. Save time as you don’t have to open, edit, or close positions yourself. Therefore, using the MetaTrader platform, you can trade online according to your busy schedule.
Economic calendar
The economic calendar is an indispensable tool for fundamental analysis. This tool displays over 500 index and economic events in a price chart. Macroeconomic indicators are updated in real time, so you are always on the lookout for market trends.
Strategy tester
Strategy Tester allows you to evaluate your trading strategies and optimize your platform’s EA. The tool can test over 40 attributes and generate a comprehensive report.
Analysis tools
Choose from an extensive selection of 46 objects, including Gann, Fibonacci, and Elliott Wave tools.

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History of CFDs

CFDs offer access to the online marketplace with a variety of margin rates, account types, and trading platforms. CFDs are relatively new, and it wasn’t until the late 1990s that individual clients were able to trade CFDs. But the growth has been quite rapid. Online CFDs have opened up many possibilities for traders, including adding derivatives. The London School of Economics (LSE) currently expects CFDs to account for more than one-third of all UK stock market trading.

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Advantages of CFD Trading

CFDs are chosen by investors because of the many advantages associated with contracts. By not holding the underlying asset, you can avoid some of the costs associated with traditional trading methods.

High leverage
CFDs offer relatively high leverage compared to other financial instruments. Deriv offers leverage up to 1:1000*, allowing traders to increase their potential return. CFDs have a lower margin rate and therefore a higher overall potential return, but it is important to keep in mind that leverage can also result in higher losses.
Long and short positions
CFDs allow you to take long and short positions in trading instruments. Because you do not actually hold the underlying asset, you can take a short position in CFD trading products with high flexibility and without worrying about additional costs.
Various trading opportunities
Most brokers offer CFDs on a variety of instruments. Trading CFDs on Deriv allows you to participate in the commodities, indices and crypto markets and take advantage of the profit opportunities and advantages associated with each market.
Disadvantages of CFD Trading
Although there are many advantages of CFDs, there are disadvantages that traders should be aware of when trading.
Spread payment
CFDs save many of the costs of traditional trading methods, but when you trade CFDs, you pay for spreads. Trading CFDs can be difficult to make small returns as you have to pay for spreads when entering and exiting positions. Spread costs should be included in the profit and loss calculation for CFD trades.
Risk
CFDs always carry risk. Trading this product is risky and traders need to devise a prudent and thorough risk management strategy as the profit and loss can surge and fall sharply. Setting a Stop Loss order can help minimize potential losses, but it does not completely eliminate the risk.

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How is CFDs taxed?

Regarding taxes, there is no stamp duty payable due to CFDs, as you do not own the underlying assets. However, capital gains tax still
applies. Overall, taxes are an area where CFDs save traders money compared to traditional trading methods.

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What makes CFD traders so successful?

Why CFD Traders Are Successful? Deriv believes that many learned traders are successful. A trader who properly understands the market and creates a trading strategy through thorough research is likely to be well prepared to respond to the actual market. That’s why it’s so important for traders to make the most of educational materials to create their own trading strategies. It is especially important to craft a strategy to minimize the influence of emotions when making important buying and selling decisions.

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Popular CFD Trading Strategy

There are several popular strategies to keep in mind when trading CFDs.

Swing trading strategy
Swing trading focuses on stocks that are expected to undergo short-term profitable price movements. Holding a position until the next day increases the risk that the market will be impacted by an unexpected event while not looking at the monitor.
Day trading strategy
As the name suggests, day traders open a position and close it within the same day, holding the position for just a few hours. Day trading avoids the risk of holding a position until the next day.
Scalping Trading Strategy
Scalping traders aim to repeat very small returns multiple times with ultra-high frequency trading in response to intra-day price movements. Hold positions for only a few seconds or minutes and aim for a small profit by trading along the trend.

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