CFD Stock Trading

CFD stock trading is a popular method that traders use to profit from the price movements of equities and the market as a whole. Investors can easily and quickly speculate on their value without the need to physically purchase company shares. Read on to find out what CFD stock trading is, how it works and how to get started. This article will also run through some popular strategies and a few trading tips to get you going. We have compiled a list of our top recommended CFD stockbrokers below.

What Is CFD Stock Trading?

A contract for difference (CFD) is an agreement between a broker and a trader that states the latter will either pay or be paid the difference between the value of an asset at the start of the contract and the end. Typically, these contracts have no expiry date and can be opened and closed whenever the trader wishes.

CFD stock trading involves derivative instruments, which means that the trader does not purchase the asset itself, they only speculate upon its price movements. Therefore, investors do not take ownership of the underlying asset. For example, purchasing a CFD on Tesla shares does not give the investor shares in the company, simply the opportunity to be paid if their value goes up.

How CFD Stock Trading Works

With CFD share trading, investors essentially make bets on the price movement of a stock, with the capability to profit from both bullish and bearish markets. CFD stock trading can be carried out by either going long or short on an asset if they believe its price will rise or fall, respectively.

Profit (or loss) is then determined by the difference between the value of the stock when the position is opened and its value when it is closed. Commissions are usually charged to open and close a CFD, typically around 0.1% for UK stocks.

Let us look at a CFD stock trading example where an investor believes the value of Lloyds Banking Group stock will rise from its current point ask/bid price of 45.55/46.55 pence. They then purchase 10,000 units going long, meaning they stake £4,655 (10,000 * 46.55p bid price), and the broker charges a 0.1% commission with a minimum fee of £8. Since the commission would only be £4.66 (0.1% of £4,655), the minimum charge of £8 is charged.

After eight hours, the value of the stock CFD has risen to 65.55/66.55 pence and the trader closes the contract for £6655 (10,000 * 66.55p), for a gross profit of £ 2,000 (£6655 – £4655). However, another £8 commission charge is taken (the 0.1% charge of £6.56 is less than the minimum). So, the total commission taken is £16 taken from a gross profit of £2,000, leaving the trader with a net profit of £1,984.

The same process is followed for short CFDs, except the price difference is in the other direction. That is, the stock price dropping to 25.55/26.55p would produce the same profit.

CFD Stock Trading Vs Spot Stock Trading

So what is the difference between CFD stock trading and traditional (spot) stock trading? Are you better off CFD share trading or just share trading?

Spot stock trading would entail purchasing some company shares if you believe the stock price will increase. This would come with all the benefits of owning the shares, gaining voting rights, dividends etc. However, if the stock price falls, you will lose money as there is no way to profit from a bearish market with spot stocks. CFD stock trading, on the other hand, does not provide ownership but allows you to profit from bidirectional price movements and execute trades much more quickly, better facilitating day trading strategies.

Each share trading style has its benefits, for example, spot stocks are probably better if you wish to hold the shares for a long time, earn voting rights and dividend yields. However, if you wish to speculate on short term price movements, CFD stock trading may be better for you. CFDs also come with the opportunity to leverage your trades, borrowing a portion of the contract cost from the broker so that you can increase your market exposure and take larger positions.

Experienced investors may use CFDs to hedge against traditional stock holdings. If you are holding for the long term but believe it may do poorly in the short term, you can purchase a selling CFD to profit from this without affecting your shareholdings.

The Influence Of CFDs On The Price Of Stocks

Does CFD stock trading affect stock prices in any way? The simple answer is no. CFDs are derivative contracts that are related to the price movement of stocks. When buying stock/share CFDs, the trader never actually buys or owns the underlying asset. Therefore, CFDs have no impact on the value of the stock they are based on.

What Platforms Can I Trade On

You might have heard that share CFD trading is only available on MetaTrader5 (MT5) but this is not the case. Even though it’s commonly associated with forex, CFD and share trading is possible on MetaTrader4 (MT4). However, MetaTrader5 was designed with CFDs in mind and therefore presents an easier interface and is more suited to a CFD stock/share trader.

There is also a large number of other, less popular, trading platforms that support CFD stock trading. Many brokers offer their own proprietary or commercial platforms, such as cTrader or NinjaTrader. If a broker offers CFD shares trading then they will almost always provide access to a platform that supports it.

CFD Stock Trading Strategies

With CFD stock trading, strategy is important. Here, we have highlighted a few of our favourite strategies, though more detail can be found on our strategies page:

Pair Trading

This strategy entails investing in two different stock CFDs, with one long position and one short. The two stocks should be highly correlated assets that have recently become less correlated. The aim is to take advantage of a divergence between the two underlying assets. You open a long position on the weaker asset and a short position on the stronger one. The direction of the market shouldn’t matter, you will be winning with one position and losing with the other. The profit is then based on the price difference between these assets, rather than the direction of their price movements.

Hedging

This is almost like a CFD stock trading insurance policy and works if you already own stocks or have open positions. Let’s say you own stocks in Coca-Cola and you believe the value is going to drop in the short term. You don’t want to sell the stock, as in the medium or long-term it should recover. This is where hedging comes in. You can go short on Coca-Cola and, if the price does drop, you can cash these in and profit from the dip in value.

News Trading

News trading is all about staying up to date with the latest announcements and releases from different companies. These will have a large impact on the value of a company’s stocks. With news trading, there are two approaches.

Firstly, you can purchase CFD contracts before the announcement in an attempt to predict the reaction to the release and the effect it will have on a stock’s price, this can be risky but rewarding. The other method is to use CFD stock trading just after the announcement, this way you can see the initial change in value and follow it. You may not profit as much, but it is less risky.

Pros Of CFD Stock Trading

No stamp duty
Higher leverage
Instant order execution
Trade short or long positions
You can offset losses against profit for tax purposes
You can use CFDs to hedge against traditional stock holdings

Cons Of CFD Stock Trading

Lack of ownership and voting rights
Financing fees for holding overnight
High concentration levels are required
You won’t earn dividends from holding contracts

How To Start CFD Stock Trading

If you are looking to start trading stock CFDs, follow this step-by-step guide:

Choose A Broker

The first thing to do to begin CFD stock trading is to find a broker. There are many brokers out there, so selecting the best one can be daunting. Here are a few things to compare:

Customer service levels
Financing (overnight) fees
How the trading platform works/feels
Deposit and withdrawal minimums/fees
Commissions or opening and closing charges
The stocks they offer or exchanges they have access to

Research The Market

Once you’ve found a broker and opened an account, you should research the market. Look at the trends for different stocks, 1- or 3-year price charts can often show regular patterns. Also, search news sites to see if there are any new developments related to the companies you’re looking at.

Open A Position

If you have found a suitable stock and know whether you want to go short or long, you are ready to open a position and begin CFD stock trading. Purchase the number of CFD contracts you are comfortable with and be sure to keep an eye on the margin you need to put down and any potential losses.

Implement Risk Management Strategies

CFD stock trading comes with a level of risk, especially if you are using margin. It is always wise to implement some form of risk management, whether it be stop loss orders that automatically close the contract once a predefined loss has been seen or a complex combination of trailing stops, hedging and size calculations.

Monitor And Close Position

Make sure you are constantly checking the market and be ready to close at any point. If you are day trading, you will want to close multiple times within a day. Alternatively, if you have a longer-term approach, you should still keep an eye on the market, and use profit calculators to ensure overnight fees are taken into account.

Trading Tips

These tips could enhance your CFD stock trading skills:

Do Your Homework: Do plenty of market research before you purchase any CFD stock contracts. Make sure you have seen all the past charts, trends and dips. History may repeat itself, so give yourself the best chance by learning about the past.
Follow The News: News releases have a huge impact on stock prices. Keep up to date on any new announcements and stay ahead of the curve.
Use A Demo Account: Demo accounts are your friend. They let you practise strategies, refine approaches and get a feel for platforms, all without spending real money. Take time on a CFD share trading demo account before you jump into the real deal.
Keep Learning: There are so many educational resources available for free that you can use to your advantage. YouTube has some great CFD share trading demo videos and there is a wealth of books and PDFs available on the subject.

Final Word On CFD Stock Trading

CFD stock trading presents a great way to profit off the price movements of different stocks on the market without owning the underlying asset. Many experienced traders are adding stock CFDs to their portfolios, both as a stand-alone instrument and as a means of hedging existing holdings. Follow our guide to start CFD share trading today and make use of our tips and strategies to give yourself a head start. Also, check out our list of top recommended CFD stock trading brokers.

FAQs

Do You Own The Stock When CFD Stock Trading?

No, you do not own the underlying stock when you trade stock CFDs. You simply speculate and profit off the price movement of the stock.

Is CFD Stock Trading Legal In The UK?

Yes, CFD stock trading is legal in the UK. Brokerages offering stock CFDs are regulated by the Financial Conduct Authority (FCA).

What Is The Best CFD Stock To Trade?

There is no simple answer as the market fluctuates so much. Stocks with the highest trading volume, liquidity and volatility are generally the best for beginners.

Is CFD Stock Trading Taxable In The UK?

Yes, CFD stock trading is taxable in the UK. It is exempt from stamp duty, but profits are eligible for capital gains tax (CGT).

Is CFD Stock Trading Safe?

No financial instrument is 100% safe as the markets are inherently uncertain and constantly fluctuating. CFD stock trading can be carried out with reduced, although still very present, risk through the use of robust risk management strategies and limited leverage.