How Does CFD Trading Work?

When you trade CFDs, you're entering into an agreement to exchange the difference in the price of an asset between the time you open and close your position. This means that you don't own the underlying asset, but you can still profit (or lose money) if its price moves in the direction you predicted (or didn’t).

For example, let's say you believe that the price of gold is going to rise. You could enter a CFD trade with a broker, opening a "buy" position on gold at its current price. If the price of gold does indeed rise, you could then close your position and make a profit on the difference.

Conversely, if the price of gold falls instead, you would make a loss on your trade.

What is the Spread

When you trade CFDs, you'll notice that there are two prices quoted: the bid price (the price at which you can sell the asset) and the ask price (the price at which you can buy the asset).

The difference between these two prices is known as the spread, and it's essentially the cost of making the trade. The narrower the spread, the less it will cost you to make the trade. For example, if you were trading CFDs on the stock of Company X and the buy price was 100p and the sell price was 99p, the spread would be 1p. This means that to open a trade on Company X, you would need to pay the spread of 1p per share.

Shares

When trading CFDs on shares, you will pay what is called the market spread and commission.

Market spread, also known as bid-ask spread or simply spread, represents the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask) for a particular financial instrument, such as a stock, currency pair, or commodity. The spread essentially reflects the transaction cost involved in executing trades within the broader market. In general, the narrower the spread, the more liquid the market is considered, as there is a smaller gap between buying and selling prices.

It's important to note that the spread can vary depending on market conditions and the specific CFD you're trading. Some CFDs may have very tight spreads, while others may have wider spreads that can eat into your potential profits.

Indices

When trading CFDs on indices, you will pay just the spread quoted on our platform. You don’t pay the market spread or commission!

You can find information on our spreads across a range of markets here.

Understanding Leverage and Margin

CFD trading allows you to trade on margin, which means you can trade a larger size position with less cash (margin). Leverage allows you to take a larger position with a smaller amount of capital, but it also increases the risks involved. For example, if a trader wanted to open a £10,000 position in an asset with a 10% margin requirement, they would only need to deposit £1,000. However, leverage can also magnify losses as well as gains, so it's important to use it carefully.

The full value of the trade in the example above is £10,000, also referred to as the notional trade size. You can calculate the notional trade size by taking the number of units bought or sold and multiplying it by the price of the asset you are CFD trading. Remember that assets trading on foreign exchanges will be denoted in their domestic currency, for example, if you buy 100 CFDs of Apple and calculate the notional trade size it will be in $.

Long and Short Positions

CFD trading allows you to go long or short on an underlying asset. Going long means that you are buying an asset with the expectation that the price will rise. Going short means that you are selling an asset with the expectation that the price will fall. With CFD Trading, you can profit from both rising and falling markets, providing you with greater trading opportunities.

Working Out Your Profit/Loss

Calculating your profit or loss on a CFD trade can be done using a simple formula:

Profit/Loss = (Closing Price – Opening Price) x Number of Contracts

For example, let’s say you opened a long position on Company X at 120p and closed the trade when the price reached 127p. You bought 10,000 contracts of Company X at 120p. Using the formula above, your profit would be:

(127p – 120p) x 10,000 = 70,000p or £700

If the trade had gone in the opposite direction and you closed the trade at 113p, you would have made a loss of £700.

Opening and Closing Orders

An opening order

• An instruction to initiate a new position in a financial instrument.
• It is used to enter a trade and take a position in the market.
• There are two common types of opening orders: a market order, and a limit order.

Market order

• An instruction to buy or sell a at the current market price.
• When a market order is placed, it is executed immediately at the prevailing market price.
• Market orders ensure quick execution but do not guarantee a specific price.

A limit order

• An instruction to buy or sell at a specific price or better.
• If the market reaches the limit price, the order is executed at the desired price or a better one.

A closing order

• To exit or terminate an existing position.
• It is used to close a trade and realise any profit or loss.
• There are three common types of closing orders: market order, limit order and stop order.
• A stop order can be used to minimise losses by closing a losing position.
• Find out more about managing your risk when trading.

The Benefits

One key difference from Spread betting is you buy or sell a specified number of units of an instrument at a given price, rather than betting per point movement as you would do with spread betting. Some of the benefits of CFD trading include:

	Tax relief*: Losses are subject to tax relief, unlike spread betting.
	Go Long and Go Short: Potential to profit from both rising and falling markets, increasing trading opportunities.
	Trade With Leverage: Trade with a smaller initial deposit for a large position.
	24-hour dealing: Trade 24 hours a day through Sunday to Friday on some of our major markets.
	Trade on the go: Place CFD trades on the move via our mobile and tablet apps for iOS and Android.

*CFD trading is not currently subject to UK stamp duty but is subject to capital gains tax. However, tax laws may well change in the future. Tax treatment depends upon the individual circumstances of each client. Please note that losses from CFD trading are currently tax allowable.