How does CFD trading work?

Trading a CFD means entering into a contract to exchange the difference in price of an asset from the time your position is opened to when it is closed. Here is a guide to the four key concepts behind CFD trading: spreads, deal sizes, durations and profit/loss.

1. Spread and commission

CFD prices are quoted in two prices: the buy price and the sell price.

The sell price (or bid price) is the price at which you can open a short CFD
The buy price (or offer price) is the price at which you can open a long CFD
Sell prices will always be slightly lower than the current market price, and buy prices will be slightly higher. The difference between the two prices is referred to as the spread.

Most of the time, the cost to open a CFD position is covered in the spread: meaning that buy and sell prices will be adjusted to reflect the cost of making the trade.

The exception to this is our share CFDs, which are not charged via the spread. Instead, our buy and sell prices match the price of the underlying market and the charge for opening a share CFD position is commission-based. By using commission, the act of speculating on share prices with a CFD is closer to buying and selling shares in the market.

2. Deal size

CFDs are traded in standardised contracts (lots). The size of an individual contract varies depending on the underlying asset being traded, often mimicking how that asset is traded on the market.

Silver, for example, is traded on commodity exchanges in lots of 5000 troy ounces, and its equivalent CFD contract also has a value of 5000 troy ounces. And in share CFDs, the contract size is usually representative of one share in the company you are trading. To open a position that mimics buying 500 shares of HSBC, you’d buy 500 HSBC CFD contracts.

This is another way in which CFD trading is often closer to market trading than other derivatives, like spread bets or options.

3. Duration

Most CFD trades have no fixed expiry on them – another way that they differ from spread bets and options. Instead, the position is closed by placing a trade in the opposite direction to the one that opened it. A buy position on 500 contracts of gold, for instance, would be closed by selling 500 contracts of gold.

If you keep a daily CFD position open after the end of the trading, you’ll be charged an overnight funding charge. The cost reflects the cost of the capital we have in effect lent you in order to open a leveraged trade.

This isn’t always the case though, with the main exception being a forward contract. A forward contract has an expiry date at some point in the future, and has all overnight funding charges already included in the spread.

4. Profit and loss

To calculate the profit or loss earned from a CFD trade, you multiply the deal size of the position (number of contracts) by the value of each contract (per point of movement). You then multiply that figure by the difference in points between the price when you opened the contract and when you closed it.

Profit or loss = (no. of contracts x value of each contract)
x (closing price – opening price)

For a full calculation of the profit or loss from a trade, you’d also remove any charges or fees incurred. These could be overnight funding charges, commission or guaranteed stop fees.

Say, for instance, that you buy 500 contracts of HSBC when it was trading at 500p per share. A single HSBC contract is equal to a single HSBC share, or one penny of movement in its share price. So for each point of upward movement you would make £5 (500 * one penny per point contract).

If you sell when HSBC shares are worth 525p per share, your profit would be £125.

125 = (500 x 0.1) x (525 – 500)

Put your theory to practise

Now you know how CFD trading works, you can put your theory into practise on IG’s platform. For more information on adding an account, finding a trade and opening your first position, take a look at how to trade CFDs with IG.

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