CFD Trading

What is CFD Trading?

CFD trading, or a Contract for Difference, is where investors don’t take ownership of asset they are investing in and allows for trading in a wide range of popular financial markets.  Traders instead speculate on the future price of the asset with what is known as a futures contract.  Online CFD trading is very popular with retail traders.

Since CFD is speculation on the price of the asset, traders in CFD trading can make money on this market if the market is either rising or falling.  CFD traders will take long positions when the market is bullish, and short positions when the market is bearish.

CFDs are leveraged products.  This means that traders only put up a small percentage of the amount in the trade, and a 3rd party like a bank will lend the trader the rest.  The money in trader’s account will then be used as collateral against the loss, but this means the profits can be much larger.

What is the best CFD trading platform?

There are many trading platforms and CFD brokers online with varying levels of regulation and reputation.  This our short list of the best CFD brokers.

What is CFD trading in forex?

CFD trading can be found in most financial markets including individual stocks, stock indexes, commodities, bonds, precious metals, and Forex.

In Forex Trading, traders are speculating on the value of currency pairs and putting in long and short positions on currencies.  Leverage is also used in Forex, and depending on the forex broker used, and your experience in trading, leverage from 1:100 to 1:1000 can be offered.

Forex Trading is popular with online traders, so if you are interested in trading Forex, read how does Forex trading works and how to develop a trading plan.

How do you make money CFD trading?

In order to make money in CFD trading, a trader needs to correctly predict the direction the market will move in and open a position.  For the few that become very good at this, it can be very profitable.

As an example, if you wanted to buy 5 shares of a company XYZ that trades at $200 you would have to pay $1000, but if you bought 5 XYZ CFD contracts at $200 and the margin was 5%. The outlay would only be $50. Any increases in the price will, therefore, be at 20 times return on invested capital, but potential losses could be just as dramatic.

CFD Trading versus Stock Trading

How does CFD Trading Work?

Each share or asset has buy and sell price known as the bid and the offer price which are derived from the underlying market. If you think the market will rise in value you buy at the ask price, called going long. If you think the market will fall in value, you sell at the bid price also called going short.

The more the market moves in the direction you predicted the more profits you make. The more the market moves in the opposite direction the more you could lose. It’s up to you how long you keep the trade open.

Traders who want to start trading CFDs need to completely understand them as a mechanism before trading. CFDs are traded on margin, you only put up a percentage of the trade as collateral based on requirements set by your CFD broker which makes it cost-effective.

Trading on margin as a trader you really wouldn’t have to put the entire cost of a trade as you would with a stock investment. You’re required to maintain a certain amount of margin in your account as defined by your CFD broker, but it’s a fraction of the cost of buying the stocks outright.

Is CFD Trading Allowed in Islam?

Traders can open Halal accounts, which the industry has named Swap-free accounts.  Swap-free accounts will stop any interest payments being made either from the broker to you, or you to the broker.

These halal accounts are more common than you may think, and so most CFD brokers do this well.  The usual way to get a swap-free trading account is to complete the regular registration process and ask your account manager to make the changes in your account.

Is CFD trading gambling?

CFD trading can be gambling if you treat it as such, but if you do your research and treat it like any other investment in the financial markets, it is not gambling.

It’s important to remember the risk of leverage as your deposit is only a small part of your overall exposure and you can lose substantially more than your deposit if the trade goes against you. However, it is possible to reduce your potential losses by using a stop order. This means that the trade will automatically be closed if it goes against you by an amount you specify.

Higher spreads can be another pitfall to CFD trading as it can ruin any potential profits.  So pick which assets you are trading carefully.

How to Start CFD trading

To get started with CFD trading you will need to find a reputable broker and open an account.  Because it is a financial trading account, the broker will require that you submit copies of your government issues identification documents and a proof of residence such as a utility bill issued in the past six months.

Once your account is set up, you will be able to make a deposit and open your first trade.

Commissions on CFD Trading

In addition to your deposit to open or close a CFD trade, you might have to pay a small commission, which can be as low as 0.1%. Other markets such as indices and Forex currencies are commission free. You may also have to calculate interest adjustments that are added or subtracted from your trade if you hold the trade overnight and consider any dividend adjustments.

How is CFD Trading Taxed in South Africa?

Profits from you CFD trading is taxable in South Africa as income.  This is even the case if the broker you are using is located outside of South Africa.  The South African government never sees CFD trading as tax-free.  For detailed information read our tax article.

CFD Summary

CFDs are designed to mirror the price of these underlying assets. This way you can take advantage of the price fluctuation without actually owning the underlying instrument. Technically a CFD is a financial contract agreement between the trader and the CFD broker and will allow you to speculate on whether you think the price will go up or down.

CFDs are a flexible and attractive alternative to other financial vehicles, therefore allows you to explore many alternative options. CFD trading allows you to make money both when the market is rising or falling. You don’t have to put up the full cost of exposure to the market and there is no fixed time period for your trade. With CFDs, you’re able to trade a multiple of your own capital using leverage.

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