CFD (Contract for Difference)
Quick Answer
A CFD, or Contract for Difference, is a derivative agreement in which two parties exchange the difference in an underlying asset’s value between the opening and closing of a position. CFD traders gain exposure to price movements without owning the underlying asset itself, and CFDs are commonly traded using leverage and margin.
How does a CFD work?
A CFD derives its value from an underlying market, which may include assets such as:
shares;
stock indices;
currencies;
commodities;
other eligible financial instruments.
The trader does not normally acquire ownership of the underlying asset. Instead, the CFD reflects changes in its price.
A trader can generally take either direction:
Long CFD: The trader seeks to benefit if the underlying price rises.
Short CFD: The trader seeks to benefit if the underlying price falls.
At closing, the difference between the opening and closing prices is applied to the size of the position, subject to applicable spreads, commissions, financing charges and other contractual terms.
Key features of CFDs
Derivative product: A CFD's value is linked to an underlying asset or reference price.
No ownership of the underlying: Holding a CFD does not normally give the trader ownership rights in the referenced asset.
Long and short exposure: CFDs can generally be used to take positions on rising or falling prices.
Leverage: Traders commonly provide only a portion of the total position value as margin.
Magnified outcomes: Because exposure can exceed the margin deposited, relatively small market moves can have a significant effect on profits or losses.
Often OTC: CFDs are commonly traded over the counter between the client and CFD provider rather than through ownership of an exchange-listed underlying asset.
Trading costs may apply: Spreads, commissions and overnight financing can affect the final result.
Simple CFD example
Suppose a trader opens a long CFD on 100 units of an instrument at:
$50
The underlying exposure is:
100 × $50 = $5,000
The market later rises to:
$53
The price movement is:
$53 − $50 = $3
Ignoring all costs:
Profit = $3 × 100 = $300
If the price had instead fallen to:
$47
the simplified loss would be:
($47 − $50) × 100 = −$300
The trader does not need to own 100 units of the underlying asset for this CFD exposure.
If leverage is used, the margin required to open the position may be substantially smaller than the $5,000 underlying exposure. However, profit and loss are still linked to the larger position exposure, which is why leverage increases risk.
This example is illustrative only and does not represent FxGrow margin requirements, leverage, commissions, spreads or execution conditions.
Potential benefits and uses
CFDs may provide traders with a way to:
gain exposure to price movements without buying the underlying asset;
take both long and short positions;
access leveraged market exposure;
trade different underlying markets through derivative contracts;
manage or hedge certain market exposures where appropriate.
However, these characteristics should not be interpreted as guarantees of profitability.
Risks, limitations and common misconceptions
A common misconception is that buying a CFD is the same as buying the underlying asset.
It is not.
When someone buys a share directly, they acquire ownership in the company. A CFD instead creates contractual exposure to changes in the share's value without ownership of that share.
Another important risk is leverage. Because only a fraction of the total exposure may be required as margin, price movements are measured against a position larger than the trader's initial margin. This can make losses develop rapidly. Regulators including the FCA describe CFDs as complex, leveraged and high-risk products.
Other potential risks include:
market volatility;
gaps and slippage;
financing costs;
liquidity risk;
counterparty risk;
margin requirements and forced position closure.
CFD protections and leverage restrictions also differ between jurisdictions. Regulatory requirements applying in one country should therefore not be assumed to apply globally.