What Is CFD Trading and How Does It Work?

A CFD is an instrument allowing traders to trade in price movements of an asset without actually owning that asset. It differs from spot trading, where you need to buy or sell an asset and wait for its price to change.

There is no delivery of the asset when you open or close your CFD positions. Opening a position, you become exposed to the price fluctuations of an underlying asset. Closing a position, you fix a profit or a loss generated as a result of those price movements. So when you use CFD, you don’t buy or sell an asset per se. Instead, you make a bet about whether or not the underlying asset price will go up or down. 

CFDs are traded on margin, meaning a trader borrows funds from the broker and uses this leverage to multiply potential gains. Leverage also works in the opposite direction, multiplying losses.

Long and Short CFD trading

Traders can use CFD to open so-called Long and Short positions. A Long position means that you will profit if the asset price goes upward, while a Short position allows you to benefit from downward movement. 

If you open a Long position and the asset price moves up, then your profit will be the net difference between the purchase price (open) and sell price (close). But if the price declines and you have a Long position, then it is unprofitable and you will fix a loss after closing it.

Respectively, when you anticipate downward movement, you open a Short position. If the price movement follows your position, then you can get a profit. Otherwise, you close the position with a loss. 

Let’s look at a specific example:

Suppose you anticipate that the BTC price will go up. You open a Long Position with BTC price on the $50,000 mark.

Because CFDs are traded with leverage, the amount of capital required to open a position of a certain size is smaller than the actual position size. For example, you use 10x leverage. That means, to open a Long Position for 1 BTC, you only need 0.1 BTC. This amount will be held in a “collateral” while your position is open and will be called “Used Margin”. With that, you will incur gains and losses from the price movements of the entire 1 BTC (with 10x leverage, it is 10 times larger than your own capital that you used).

When you open the position, you will not actually own 1 BTC. You are just speculating on the future price movements. If your bet plays out, you will get gain. If not — you will incur a loss.

Suppose the BTC price increases to $55,000. That means, with your leverage, you are in for $5,000 gains (Close Price – Open Price). Your net profit is that minus the fees (as there could be broker fees for the opening position, closing it, and for keeping it open for a number of trading periods). CEX.IO Broker is commission-free, so your net profit in this scenario will stay $5,000.

On the other hand, if the price drops to $45,000, your loss will be -$5,000 (Close Price – Open Price).

It is important that leverage both multiplies potential gains and losses. Hence, CFD trading is considered an advanced trading strategy connected to higher risks.

Cost to use CFD

CFD contracts have two prices: the buy price (ask) at which you open a Long position and sell price (bid) at which you open a Short position. A bid price will always be slightly lower than the current market price, while an ask price will be slightly higher. The difference between the buy and sell prices is called spread.

In most cases, the cost to use a CFD contract is covered in a spread. Different brokers may also have additional commissions for CFD trading.

CFD size

If you want to trade CFD, you need to specify the number of lots for your position. Lot specification varies depending on the underlying asset. For example, 1 lot on the BTC market equals 1 BTC. If you want to open a 0.5 BTC worth position, then you may specify 0.5 lots for your position.

CFD duration

CFD is a derivative. But unlike options or futures with physical delivery, CFD doesn’t have a fixed expiry date. The CFD position is closed by placing the order in the opposite direction to the one that opened it. For instance, a 1 BTC worth buy position would be closed by 1 BTC worth sell position.

Disclaimer: For information purposes only. Not investment or financial advice. Seek professional advice. Digital assets involve risk. Do your own research.

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