How does CFD trading work?

What is a CFD?

CFDs (contracts for difference) are particularly speculative derivatives. They are generally used for pure speculation on the price trend of an underlying asset assigned to them. CFDs belong to the group of derivatives. Generally, the price of a CFD is derived directly from the individual underlying, for example, from an index or a share.

Even for an experienced investor, an investment in CFD products is always a speculative investment because investors can open high trading positions with little capital investment. Therefore, the considerable risks of this CFD speculation cannot be completely avoided.

Therefore, it is advisable for investors to study in detail the general functioning, products, markets and mechanisms of CFDs.

Will my CFDs expire at some point?

The CFDs generally do not expire. Compared to options or futures, for example, they do not have an end of term. For example, if you hold a commodity CFD that relates to a copper future, for example, the CFD will also not be closed when the future expires at some point. Instead, the CFD is rolled into the next future contract.

Another risk is an automatic closing of the CFD. This action happens when the loss of a CFD position has reached the amount of the paid margin. In this case, the CFD broker would close the position, as losses exceeding the performance would not be covered. Thus, the position expires. A total loss has then occurred, the risk of which increases with a higher leverage.

 Do I have to pay taxes on CFDs?

CFDs are treated as forward transactions for tax purposes. Thus, the profits from CFD transactions are subject to the final withholding tax that has been in force since 2009. Such a tax amounts to 25 percent plus solidarity surcharge and possibly the church tax. Since CFD brokers are usually not directly regulated by BaFin, they do not pay the tax directly. Therefore, you have to enter the profits or losses in the tax return yourself.

Which markets can I trade with CFDs?

CFDs are derivative products that allow investors to trade on a specific margin. This helps to get an optimal access to the financial markets. Thus, the investor can trade the CFDs on different asset classes, such as indices, stocks, commodities, cryptocurrencies or currencies.

The selection of tradable markets is an important decision criterion for a good CFD broker. This is one of the biggest differences between CFD brokers. Especially those who want to trade special values and smaller stock companies must look closely here.

While the classic underlyings such as S&P500, gold and well-known individual stocks such as Apple or Microsoft can be traded almost everywhere as CFDs, small-cap stocks must be research more closely.

 What are the fees for CFD trading?

In terms of fees for CFDs, there are essentially the spreads and overnight financing. Partly CFD brokers still charge commissions, but with most CFD brokers you can trade CFDs commission-free.

Spreads are one of the most important sources of income for CFD brokers. A spread is the difference between the current buy and sell prices on the market. Favorable spreads are an important feature for a good CFD broker.

However, the spreads are not only different from CFD broker to CFD broker. The individual underlyings also have different spreads, depending on their liquidity in the market. Forex CFDs generally have the most favorable spreads, as liquidity is highest here. Very volatile meme stocks or penny stocks, among others, have the highest spreads.

 Is there a risk of total loss in CFD trading?

Total loss in CFD trading is possible in principle, but avoidable. The total loss occurs when the capital deposited with the CFD broker (margin) is completely used up by losses of CFDs. However, before the total loss occurs, you get a warning from the CFD broker, also called margin call.

In the case of a margin call, the CFD broker informs you that the deposited margin has fallen below a critical level. If you do not add new capital and the losses increase, the CFD broker automatically closes the CFDs and the total loss occurs.

The greatest risk in CFD trading comes from very high leverage with very high volatility. Here traders can quickly be caught on the wrong foot and the CFDs run into the loss zone. Therefore, it is important not to use too high leverage in CFDs. Likewise, the individual CFDs should not contain too high a proportion of the margin. It is advisable to always have some margin "free" in the account to avoid getting into the margin call area.

 How does a CFD broker make money?

The fact that CFD brokers earn money from the losses of their customers is not the case with reputable brokers. The main sources of income for CFD brokers are the fees for CFD trading. The more and the more frequently CFDs are opened and closed, the more a CFD broker earns.

Commissions are also part of the revenue stream. However, many CFD brokers do without these fees because of the strong competition between brokers. Significantly, CFD brokers earn money from spreads, which is the difference between the buy and sell price. Furthermore, they earn money from the overnight funding that is incurred when holding a CFD overnight.

 How do I open an account with a CFD broker?

Opening an account with CFD brokers is very similar to opening an account with normal brokers for stocks. Registering with a CFD broker is done online and can be done in a matter of minutes. However, in order to trade with real money, CFD brokers require additional personal details and identity verification documents.

The most complex part of signing up with a CFD broker is choosing the right one. The market of CFD brokers is huge and the functions and offers must fit the trader's goals. Therefore, it is advisable to compare CFD brokers and possibly sign up with several brokers.

 How do I find a good CFD broker?

When choosing the right CFD broker, there are some important criteria to consider. At the top is the seriousness of the CFD broker, so that your money is safe. Therefore, you should pay attention to an appropriate regulation by common regulatory authorities, such as a regulation by the German BaFin, the Cypriot CySEC or the British FCA.

Another important criterion for a good CFD broker is the range of tradable markets. This is one of the biggest differences between CFD brokers. A large selection gives good flexibility in CFD trading and offers more opportunities.

Another important aspect to consider when choosing a broker is the CFD platform itself. Is it clearly laid out? Is all the information easy to find? How can you deposit and withdraw money? How can the customer service be reached? These are all important questions to pay attention to. CFD trading via a mobile app should also be available in order to be able to react quickly and from anywhere.