CFD Trading for Beginners in the UK

If you have been interested in trading, you must have encountered CFDs and the constant warning that often follows them. The disclaimer usually says they are highly speculative and high-risk, and you could lose money. While it’s true that CFDs are high risk, it’s also true that high risk brings high rewards. Any investment with a huge loss potential equally has a high payout potential. That’s what they don’t tell you. Thank goodness in this piece, we discuss CFD trading UK, how to get you started, and what to watch out for in this high-end game.

What is CFD Trading?

Before we even define CFD trading, what is a “Contract For Difference” or CFD?

A CFD is a special tradable agreement that allows you to predict the shooting or falling of prices of an asset. You just predict the price, not buying the asset, so you don’t own the CFD’s underlying asset.

In this agreement, you and the CFD seller agree to exchange the difference in the value of a financial product between now and when the contract closes. 

Practically, you make money by correctly predicting price changes without buying the asset. You benefit profit if your predictions are correct, but you lose money if they’re wrong. 

Back to our question: what’s CFD trading?

In practical terms, we use “CFD trading” and “CFDs” interchangeably. Both terms describe the activity of trading Contracts for Difference. However, “CFD trading” specifically means engaging in trades using CFDs, whereas “CFDs” is a more general term that refers to the financial instruments themselves. 

So; CFD trading describes buying and selling financial derivatives without owning the underlying asset.

How Does CFD Trading Work?

Trading CFDs involves predicting price movements in financial markets. Unlike traditional trading, which terminates with the exchange of ownership, there is no transfer of ownership in CFD trading. Instead, CFD investors speculate on the price movements of assets without owning them.

For instance, rather than purchasing oil barrels, you speculate on whether the price per barrel will rise or fall. If the trader buys a CFD and the price of oil increases, they can sell the CFD at a profit based on the price difference. Conversely, if they sell a CFD and the price decreases, they can buy it back cheaply and profit from the difference. Here are the basic concepts.

Opening Positions

You decide the direction of price movements, up or down, and open a CFD position. You do this based on your prediction of how the asset’s price will move. The position is either you go long – “Buy” –  or go short – “Sell.” The result can either be a profit or a loss.

When you open a CFD position, you agree to settle the difference in the asset’s price from opening to closing the contract.

Use CFD Leverage 

CFD trading often allows you to borrow money to open and control larger positions with a smaller upfront investment. Since you are staking borrowed money, you magnify both your potential gains and losses, so you must exercise caution.

When you use leverage in CFDs, you only stake a percentage of the full value. The broker loaned you the top-up to gain the full position. This small initial deposit is the margin.

Here is an example:

Close Position (Settlement – Profit or Loss)

At the close of the contract, the CFD broker credits or debits your brokerage account with the net profit or loss. You also incur a commission on trades depending on the broker you choose and the market you trade.

Employing portfolio management tactics to manage your risk levels would be best. Stop-loss orders help you limit the loss you can suffer. Also, spread your choices in various financial markets, including stocks, commodities, currencies, and indices. After all, you don’t need to own them.

How to Start CFD Trading UK: Step-by-step Guide

CFDs and spread betting in trading are from the school of thought – they are high-risk complex instruments as they use leverage. So before you try CFD trading, you must understand its ins and outs and be confident you can stomach the risk. Don’t just focus on the profit potential, but the downside potential as well.

Having said that here are the basic steps in starting CFD trading in the UK:

1. Learn CFD trading

You are already doing well. In the previous sections, we have explained CFD trading and how it works at length, which gives you a head start already. You already know that it involves buying and selling Contracts for Difference (CFDs), financial derivatives that predict the rise and fall in prices of various assets. The assets could include shares, indices, commodities, and forex. You don’t buy these assets, but profit or loss based on the price difference at the start and close of the contract period.

For risk-free learning, practice with a demo account using virtual funds. That way, you can develop skills and strategies before trading with real money. 

2. Pick your CFD broker, and create and fund CFD trading account

Many trade brokers claim to offer CFD trading, but each has different types of accounts. We review these brokers and help you pick the best FCA-regulated broker. But if you are shopping for one by yourself, always pay attention to these areas in particular: 

The broker’s range of markets includes individual stocks, currency pairs, indices, exchange-traded funds (ETFs), and commodities.

The leverage and margin: In our example above, the broker offered a 20% margin and a leverage ratio of 20:1. The ratio indicates how much larger our position in the example can be against our initial investment. In our case, it’s 20 times your initial investment. But note that the FCA now limits retail clients’ access to leverage. You must prove you are eligible to trade with a 500:1 leverage or be content with 30:1 or 20:1. But this is for your good. A huge leverage ratio is of no use to a beginner. 

Commissions and spread: All brokers make money through commissions and spreads. They often clearly state this in their terms of service. In most cases, they charge a percentage of a position’s size, especially for crypto and share CFDs. You want a broker whose percentage rate doesn’t burden you too much.

Ease of transacting and associated costs: Check the payment options, and if you are comfortable with the available options, look at the initial deposit requirements. You also want a broker who offers quick and convenient transactions at an affordable rate, whether deposits or withdrawals.

If the broker checks all your preferred boxes, open your account with them and verify it. You can then fund it with your favourite deposit method.

3. Choose your market, timeframe and trades

Select the market you want to trade from various options, including shares, indices, forex, commodities, etc. Decide if you wish to trade in the spot market for short-term trading or futures for medium to longer-term positions.

Open your trade, and, based on your market analysis, intuition or whatever you use, decide whether to take a ‘buy’ position (if you expect the price to rise) or a ‘sell’ position (if you expect the price to fall).

4. Monitor and manage your trades 

Once your trade is open, monitor its performance through the trading platform. Based on market movements, you can close your position at any time to take profits or limit losses.

Set stop-loss orders to close your trade if it moves against you automatically, and set profit-taking limits to secure your gains. These risk management tools help you control potential losses and lock in profits.

CFD Trading Risks in the UK

Even though CFDs are quite popular, a beginner CFD trader might need assistance. But they say, forewarned is forearmed. So, you must know what you’re doing and the dangers involved. Discipline and attentiveness in monitoring your positions are arsenals you can’t ignore. The idea is to have a level head regardless of market volatility. Don’t let your emotions get in the way. 

The common risks associated with trading CFDs for beginners include:

• Leverage Risk: This danger results from using leverage ratios and can cause you to lose more because of the trading margin. Still, you can handle this risk by using a stop-loss order to limit its extent. 
• Risk of Over-trading: Indisciplined beginner CFD traders may get carried away and place more trades, only thinking of profits. But such trades mean more transaction costs, which can quickly overburden you.
• Market Volatility: Financial market prices fluctuate rapidly, making the market highly volatile and causing sudden and unexpected losses. Plus, CFDs are complex, and the changes therein might be confusing. Knowing when to open and close a position requires an understanding of the market fundamentals and technical analysis.
• Counterparty Risk: Any CFD trader is in a contract with a broker firm, and that means if the broker faces financial difficulties or goes bankrupt, you may struggle to recover your funds. It’s essential to choose a reputable and FCA-regulated broker.
• Margin Calls: Your broker may require you to top up to maintain your position if the market moves against it. If you don’t, the broker may close the position, causing you losses.

Pros & Cons of Trading CFD

Pros:

• Leverage: CFDs leverage, though risky, allows you to use a relatively small initial investment, maximizing your potential returns on capital. It enables traders to make large profits from small market movements.
• Diverse Markets: You can trade a wide range of markets, including stocks, indices, commodities, forex, and more, from a single platform. This diversity offers opportunities to diversify your trading portfolio and access global financial markets quickly.
• Profit from Rising and Falling Markets: CFDs enable you to take long (buy) or short (sell) positions, allowing you to profit from upward and downward price movements. This flexibility helps in capturing opportunities in various market conditions.

Cons:

• High Risk of Losses: The leverage involved is a double-edged sword. A relatively small initial investment for a margin could mean substantial losses should the market goes against your favour.
• Costs: Trading CFDs involves spreads, commissions, and overnight financing charges. These costs impair your profitability.

Conclusion

As you begin your journey into CFD trading, it’s crucial to understand your risk appetite. Are you naturally cautious and risk-averse, or do you have a higher tolerance for risk? Knowing this can significantly impact your trading decisions and strategies. But generally, CFD trading is an advanced form of investment and is typically a field of experienced traders. It’s a powerful option for capitalizing on short-term market fluctuations but carries significant risks.

If you are ready to explore CFD trading confidently, pick a broker here and try CFD trading in demo mode. You can also learn a few things, including risk management techniques tailored to your trading style, right here. Equip yourself with the knowledge to trade wisely and effectively. Start learning now and make informed trading decisions!