How to Profit from Market Swings with Contract for Difference
CFDs are financial instruments that allow you to speculate on the price changes of various financial assets. They provide more trading features and investment opportunities for advanced traders who understand how they work.
What Are CFDs and How Do They Work?
A contract for difference (CFD) is a financial instrument that permits traders to bet on the price changes of various assets without possessing the underlying securities.
They are popular for their simplicity and can be traded online on your desktop or mobile, similar to how you might be trading shares or other commodities today.
However, when trading a CFD in a share like Tesla, you don’t trade actual Tesla shares; you trade Tesla’s share price in a contract between yourself and a CFD broker like OANDA. If you think the price of Tesla shares is rising, you buy, which is called going long.
If their latest business does not convince you and you think they’re about to go down, you can profit from a falling share price and sell, which is called going short. But if the price moves against your position, you pay the difference.
CFDs do not have an expiration date or conditions typically tied to traditional investments, which gives traders the freedom to use any strategy without limitations. Furthermore, CFDs are not subject to stamp duty in Canada.
With a CFD account, you can trade on over 10,000 markets worldwide.
Popular options include shares of companies like Apple and Tesla, currencies like the US dollar, euro, or British pound, and commodities like oil and gold. CFDs are leveraged products, so you can take a much larger total position with just a small margin.
Advantages of Trading CFDs
Ability To Go Long or Short
When trading CFDs, you are speculating on whether the price of an asset will increase or decrease. If you expect the price to rise, you ‘buy’ (go long); if you anticipate the price to fall, you ‘sell’ (go short). This feature enables you to profit from even falling markets.
CFDs Are Leveraged Products
Leverage enables you to maximize your capital by reducing the upfront deposit required to open a position. In leveraged trading, you use the funds in your brokerage account as a margin deposit, meaning you only need to commit a fraction of the total position’s value.
However, any profits or losses will be calculated based on the full size of your position, not just the margin amount.
Here’s an example using a different leveraged product: gold futures. Imagine you invest $200 into a gold futures position with 5x leverage. This means the total value of your position is $1,000.
If the price of gold increases by 4%, your position would rise to $1,040, giving you a profit of $40. Alternatively, if gold prices decrease by 4%, your position would drop to $960, resulting in a $40 loss. Without leverage, the same price movement would yield a profit or loss of just $8.
Access to Many Markets
CFD brokers offer products covering major financial markets worldwide, including stocks, forex, and cryptocurrencies, from a single platform.
This global reach allows traders to participate in markets across different regions and time zones.
Disadvantages
CFD Trading Costs
One disadvantage of trading contract for difference is its cost, which can get very expensive in the long run and negatively affect your profit. The two most common fees are spread and overnight financing fees.
Spread is the difference between a CFD bid (buy) and ask (sell) price, which is what the broker receives in exchange for making the trade. Spreads are relatively low, but they can seriously erode your margin if you trade regularly or prefer volatile markets.
Overnight or financing/rollover fees apply when you trade leveraged CFD positions at night. These fees are related to borrowing the capital required to continue the leveraged position and depend on interest rates and market circumstances.
Depending on the length of time you’re trading, these fees will add up and drain your profits over time.
Therefore, traders should keep an eye on these expenses when trading with CFDs, especially in long-term trading or volatile markets.
How Can Canadians Trade CFDs?
CFDs are legal in Canada, but the market is highly regulated. For example, the Canadian Investment Regulatory Organization (CIRO) has established very restrictive rules regarding the contract for difference trading, such as margin limits.
These margin regulations might reduce the amount of leverage available to Canadian CFD traders compared to their European counterparts.
Regardless, traders should only sign up with brokers registered with the Canadian Investment Regulatory Authority (CIRO).
Here is a step-by-step guide:
Choose a regulated broker
Make sure the broker is authorized by CIRO and offers features like tight spreads and a user-friendly platform.
Open a trading account
Sign up with your chosen broker and create an account.
Start with a demo account
Practice trading risk-free to learn how CFDs work and test your strategies.
Fund your live account
Once confident, deposit funds into your live account.
Analyze the market and choose an asset
Conduct proper market research and analysis on your chosen CFD (e.g., shares, currencies, commodities).
Place and manage trades
Execute your trade and actively monitor and manage it to minimize risk and maximize potential returns.
Is CFD Trading Taxed In Canada?
Yes, Contract for Difference (CFD) trading is taxed in Canada. Profits earned from CFD trading are considered taxable income, but how they are taxed depends on how the Canada Revenue Agency (CRA) classifies your trading activity.
If you are a day trader or engage in frequent, high-volume CFD trading, your profits will be taxed as business income. In this case, the income is taxed at your full marginal tax rate.
On the other hand, if you are an investor who trades CFDs infrequently and holds positions over a longer period, your profits will likely be taxed as capital gains. For capital gains, only 50% of your profits are subject to taxation at your marginal tax rate.
Trade Smartly and Responsibly with Contract for Difference
As versatile instruments, CFDs allow Canadian traders to speculate on the world’s markets without owning assets. They allow you to trade on go long or short and access thousands of markets from one platform.
This makes them attractive to more experienced traders as well as investors seeking a change of pace.
CFD trading is regulated in Canada, so it’s important to trade only with brokers registered with CIRO. You will also want to know how your trading activity will be taxed, as business income or capital gains.