Key points
- A CFD tracks an asset’s price, yet you never own the asset. You make your contract with the provider, not an exchange.
- The provider holds a margin deposit from you, which covers only a fraction of the trade’s value. Your profit or loss is still based on the full trade size, not on that deposit.
- Whether the price moves or not, costs such as the spread, commission and overnight financing build up. That’s why how long you hold a trade matters more than most traders expect.
- From a single account you can trade shares, indices, currencies, commodities and cryptocurrencies. That’s why people turn to CFDs to access markets that would otherwise call for multiple separate accounts.
How the contract works
A contract for difference is a derivative: a contract whose value is based on the price of something else. That something else is called the underlying, and it can be a share, a stock index, a currency pair, a commodity or a cryptocurrency. The two sides to the contract are you and the CFD provider.
When you close the contract, you and the provider multiply the size of your trade by the change between the opening and closing price. If the price moved your way, the provider pays you that amount. If the price moved against you, you pay the provider. Nobody hands over shares, barrels or coins at any point.
The contract is settled in cash and isn’t traded on an exchange. Most CFDs are open-ended with no expiry date and stay open until you close them or the provider closes them under your account terms. Each day the contract stays open, the provider charges you overnight financing or sometimes pays you. That daily charge is why CFDs are built for short holding periods and suit long-term investing poorly.
CFDs are known as leveraged because your provider only needs a portion of the total trade value as margin. You might open a trade valued at ten thousand dollars using a few hundred dollars of your own funds. Yet your profit or loss is still calculated on the full ten thousand dollars.
Key features
Four short lines cover the key features of a CFD.
- Trade price movementsTrade on prices going up or going down.
- No ownership neededYou don’t own the underlying asset.
- Wide range of marketsTrade forex, indices, commodities, shares and more from one account.
- Use leverageControl a larger trade with a smaller deposit.
The four parts of a CFD trade
A CFD trade has four parts: a direction, a size, the margin the provider holds against it and the prices at which you open and close it. The provider sets or quotes each part, and your platform shows the direction, size, margin and prices while the trade stays open.
Direction: long or short
The direction of a CFD trade is long when you think the price will rise, and short when you think it will fall. You open a long trade at the provider’s ask price. The ask price is the higher of the provider’s two prices. You close it at the bid, the lower one. A short trade works the other way round: you open at the bid and close at the ask. Going short on a CFD doesn’t involve borrowing the asset, and that’s one reason people use CFDs to trade on falling prices. Share CFDs can still carry a borrowing charge on short trades (shares and crypto CFDs).
Size and notional value
The size of a CFD trade is measured in units of the underlying: shares, index points, lots of currency, barrels or ounces (pips and lots). You get the notional value by multiplying that size by the current price, so it equals the full value of what you trade. Your profit and loss are worked out on the notional value, not on the margin you put down. Platforms usually show this figure as the trade’s exposure. A percentage price move applies to the exposure, not to your margin.
Margin held against the trade
Margin held against a CFD trade is the deposit your provider asks for to open the trade and keep it open. The figure is a percentage of the notional value, and the exact percentage varies with what you trade. If the company that opens your account is regulated in the EU, the retail rules of the European Securities and Markets Authority (ESMA) apply. They set initial margin from 3.33 % for major currency pairs to 50 % for cryptocurrencies (ESMA Decision (EU) 2018/796). A global company in the same group sets its own margin. You can find the full breakdown on the leverage and margin page. Margin isn’t a cost. It stays in your account and comes back to you when the trade closes, minus any loss.
The price you get: bid, ask and spread
When you trade a CFD, the price you get is the provider’s own quote, always given as two prices. The bid is what the provider buys from you at, and the ask is what it sells to you at. The spread is the gap between those two, and it’s the first cost on any trade. Open a trade at the ask, close it right away at the bid and you lose the spread. Quotes are based on the underlying market but aren’t the market itself. The provider may widen the spread around news, at the market open or overnight.
A worked example: 100 CFDs on a share priced at 50
Illustrative figures: a made-up example, not a forecast or a quote.
A worked example shows how the numbers in a CFD trade link together. The prices and trade sizes are made up. Say you buy 100 CFDs on a share where the quote is 50.00 bid and 50.05 ask. The margin rate is 20 %. This is the retail rate for individual shares at a company regulated in the EU (ESMA Decision (EU) 2018/796). You close the trade after a 5 % price move, whether higher or lower.
| Price rises 5 % | Price falls 5 % | |
|---|---|---|
| Opening price (ask) | 50.05 | 50.05 |
| Notional value at opening | 5,005 | 5,005 |
| Margin held (20 %) | 1,001 | 1,001 |
| Closing price (bid) | 52.50 | 47.50 |
| Profit or loss on 100 units | +245 | −255 |
| Return on margin | +24.5 % | −25.5 % |
A 5 % change in the share price moved your margin by about a quarter, up or down. That’s leverage at work. The spread skewed the result: you gained 245 when the price rose and lost 255 when it fell. At a company regulated in the EU, major currency pairs need only 3.33 % margin (ESMA Decision (EU) 2018/796). With those same sums, a 1 % move swings your margin by about 30 %.
What a CFD doesn’t give you
A CFD grants you exposure to a price alone, so it lacks four things you would get by owning the asset.
- No ownership. A share CFD doesn’t give you any shares, voting rights or the right to attend company meetings. When the company pays a dividend, your provider makes a cash adjustment to your account instead of the dividend.
- No exchange. The contract is over the counter, made directly between you and the provider. The provider is your counterparty and sets the quote, and the terms are its own, not an exchange’s rulebook.
- No delivery. You never receive barrels or ounces from a commodity CFD, and a currency CFD never exchanges one currency for another. Every contract is settled in cash as the difference.
- No expiry, but holding isn’t free. Most CFDs have no expiry date, yet an open trade keeps costing you money through the daily financing charge. Owning a share or a physical asset carries no such running cost.
CFDs are designed for short-term price exposure, so missing ownership isn’t a flaw in itself. Issues arise when people treat a CFD as if it were an investment it doesn’t match.
CFDs compared with shares, futures and options
Comparing a CFD with a share, a futures contract and an option highlights the differences between them. A future is an agreement to buy or sell at a set price on a set date and is traded on an exchange. With an option, you have the right to buy or sell, but not the duty. People often confuse CFDs, shares, futures contracts and options, yet they differ in ownership, where they trade, expiry and how leverage works.
| CFD | Share | Exchange-traded future | Exchange-traded option | |
|---|---|---|---|---|
| Ownership of the asset | None | Yes | None | None (a right, not the asset) |
| Where it trades | Over the counter with the provider | Exchange | Exchange | Exchange |
| Counterparty | The provider | The market via a broker | The clearing house | The clearing house |
| Expiry | Usually none | None | Fixed date | Fixed date |
| Leverage | Built in through margin | None unless borrowed | Built in through margin | Built in through the premium |
| Holding cost | Daily financing | None | Priced into the contract | Time decay of the premium |
| Retail leverage caps (EU, UK and Australian companies) | Yes | Not applicable | Set by exchange margins | Not applicable |
Legitimate uses of a CFD
CFDs do have legitimate uses, and a fair account of the product covers them. The clearest one is hedging: protecting something you already own. Say you hold shares and expect a short spell of weakness. You cancel your exposure with a short CFD of the same size, instead of selling the shares. When the worry is gone, you close the CFD.
CFDs let you trade on a falling price, something most retail investors struggle to do through other means. CFDs also give you access in small sizes to markets like stock indices and commodities. Usually, trading those without CFDs would mean opening a futures account and committing to a far larger minimum contract.
All three uses of a CFD serve a clear purpose and have a fixed holding period. A CFD is not suited to open-ended speculation without an exit plan, yet that’s how the contract is most often advertised. The trading strategies page explains why the contract’s costs determine which approaches can work at all.
Gap risk and correlation risk
Leverage figures alone hide two dangers in a CFD: gap risk and correlation risk. A gap is a price jump where no trading occurs, often striking when a market opens after news. Your stop-loss is the order meant to close your trade at a set price. If that order lands inside the gap, it fills at the first available price on the far side, which can be well past the level you chose (stop-loss orders). Losses are worked out on the notional value, so a gap of a few per cent can wipe out much of your margin before any order can act.
Correlation risk is the chance that several trades which look separate all move together. Suppose markets sell off while you hold long CFDs on two stock indices, a commodity currency and oil: those four trades behave almost like one trade four times over. The margin close-out rule closes your trades when your account runs too low and looks at your whole account at once.
The risk management page explains how you can handle both risks through trade sizing and account-wide limits. The risk disclosure sets out every type of risk the product carries.
Common questions about contracts for difference
Common questions about contracts for difference cover what the name means, ownership, how much you can lose and why regulators treat CFDs differently from shares.
What does CFD mean?
CFD stands for contract for difference. You and a provider agree to settle in cash whatever the asset’s price has gained or lost between the moment you open the trade and the moment you close it. The plural form is CFDs, and you never own the asset the contract follows.
What is CFD trading?
CFD trading means opening and closing contracts for difference to make a gain or loss from a price change, up or down, without owning the asset. You put down margin, pay the spread and cover any overnight financing. Your profit or loss is worked out on the full size of the trade. The how CFD trading works page tracks one trade from quote to statement, and the how to start trading page lists the steps before your first trade.
Can you lose more than you deposit on a CFD?
A CFD can lose more than the margin held for a single trade. Losses are calculated on the full notional value, and a price gap can leap right past your stop-loss. Most individual traders are retail clients, the default category with the most protection. At a company regulated in the EU or the UK, negative balance protection caps a retail trader’s total loss at the money in the account (ESMA Decision (EU) 2018/796, FCA PS19/18). A professional client may owe more than the balance, and a customer of a provider outside those rules may do the same.
Why are CFDs regulated differently from shares?
CFDs are regulated differently from shares because they mix leverage, a provider on the other side of every trade and sales aimed at ordinary retail customers. Regulators found that this mix led to steady losses for most customers. For the leverage caps that followed in the EU, the UK and Australia, see the maximum leverage page. The choosing a provider page explains how to check whether the company that opens your account has to follow them. To separate the risk of losing money from the risk of fraud, read the is forex and CFD trading safe page.
Sources
The original documents this page cites, in the order they first appear.
- European Securities and Markets Authority, ESMA
- ESMA Decision (EU) 2018/796 of 22 May 2018 to temporarily restrict contracts for differences in the Union, Official Journal of the European Union (EUR-Lex), 2018-05-22
- Financial Conduct Authority, FCA
- PS19/18: Restricting contract for difference products sold to retail clients, FCA, 2019-07-01