CFD Trading Explained: How Contracts for Difference Work and Their Risks

A contract for difference (CFD) is an agreement between you and a broker to exchange the difference in the price of an asset between the time you open and close the position. You never own the underlying share, index, commodity or currency. You only gain or lose based on its price change.

How a CFD trade works

1. You open a long (buy) or short (sell) position on, for example, an index CFD.
2. You post margin, a fraction of the position's value.
3. While the position is open, gains and losses are applied to your account.
4. When you close, the difference between the opening and closing price, times your size, is your profit or loss, less costs.

Example: you buy 10 CFDs on an index at 18,000 with a value of $1 per point per CFD, and close at 18,120. Profit: 120 points × 10 × $1 = $1,200, before spread and financing.

Costs

• Spread: the main cost on many CFDs.
• Commission: common on share CFDs.
• Overnight financing: holding a leveraged position overnight usually incurs a daily charge (and sometimes a credit on shorts), which adds up over weeks.
• Currency conversion if the CFD is priced in another currency.

The risks

CFDs are leveraged and complex. Regulators require brokers in many regions to show the percentage of retail accounts that lose money trading CFDs, and these figures are often well above half. The European Securities and Markets Authority (ESMA) and national regulators such as the UK's FCA have introduced retail protections including leverage limits, margin close-out rules and negative balance protection.

Key risks:

• Leverage magnifies losses. See leverage and margin.
• Gaps can move price past your stop.
• Counterparty: you trade with the broker, not on an exchange.
• Financing costs make CFDs expensive for long holds.

CFDs are not available to retail traders in some countries, including the United States.

Managing CFD risk

• Size from your stop, not from available leverage. See position sizing.
• Use stops, and understand your broker's guaranteed stop options if offered.
• Track financing costs; they may matter more than you expect.

Tracking CFDs

Many CFD traders use MetaTrader 4, MetaTrader 5, cTrader or broker platforms such as IG. TradeThink treats CFDs as their own asset class and can import CFD history from MT4, MT5, cTrader, IG and other CFD brokers, including commissions and swaps. See also journaling MT4 and MT5 trades.