What Is a CFD? Contracts for Difference Explained

What is a CFD? A contract for difference is an agreement between you and your broker to exchange the difference in an asset's price between the time you open a position and the time you close it. You never own the underlying asset, whether that is a currency pair, an ounce of gold or an index. You only trade the price movement, which is why CFDs are called a derivative product.

How does a CFD actually work?

When you open a CFD position, you choose a direction. If you expect the price to rise, you go long. If you expect it to fall, you go short. When you close the position, the difference between the opening price and the closing price is settled in your account as profit or loss.

Nothing is delivered. A CFD on gold does not give you any metal, and a CFD on an index does not give you the companies inside it. You hold a contract whose value follows the market price, which you can see on the markets pages.

Because you do not own the asset, you can go short as easily as long. That flexibility is useful, but it also means a position can lose money in either direction if the market moves against you.

How are profit and loss calculated?

The basic sum is the price change multiplied by the size of your position. Here is a simple example with round figures, for illustration only.

Suppose an index is at 20,000 points and you open a long position of 1 contract, where each point is worth 1 dollar. You go long at 20,000.

• If the index rises to 20,100, you gain 100 points, which is 100 dollars
• If the index falls to 19,900, you lose 100 points, which is 100 dollars

A short position works the other way round. The same 100-point fall would give you a 100-dollar gain, and a 100-point rise would cost you 100 dollars. Costs such as the spread are added on top, and we cover them below.

You can test sums like this on the profit calculator before you ever place an order.

What is the role of leverage and margin?

CFDs are traded on margin, which means you put up only a fraction of the full position value. The broker lends the rest. The ratio between the two is leverage. If leverage is 1:100, a 1,000-dollar deposit can control a position worth 100,000 dollars.

This is where beginners get caught. Leverage magnifies both gains and losses, because your profit or loss is based on the full position size, not on the margin you put up. For example, if you hold a 100,000-dollar position and the price moves 1%, that is 1,000 dollars, which could be your entire margin.

Leverage makes a small account act like a large one, and that works in both directions.

Use the margin calculator to see how much margin a position needs before you open it. If your losses grow so that your account no longer covers the required margin, the broker may close positions to limit further losses.

What does it cost to trade CFDs?

The main cost is the spread, the gap between the price you can go long at and the price you can go short at. You pay it when you open the position, so every trade starts slightly behind. Some accounts add a commission per trade as well.

Holding a position overnight can also add a financing charge, because you are using borrowed money for the extra days. Charges vary by instrument and account, so check the details before you trade. DMA Capitals, for instance, offers a Standard account with spreads from 0.3 pips and zero commission, and Executive and Corporate accounts with tighter spreads plus commission.

What are the risks of CFD trading?

The risks are real and worth reading slowly:

• Leverage: losses can exceed what you expected because they are based on the full position size
• Fast markets: prices can jump past your planned exit, especially around major news
• Short-term focus: CFDs reward discipline, and many beginners trade too large and too often
• No ownership: you hold a contract, so you do not receive the rights of owning the asset

Trading CFDs carries significant risk and is not suitable for everyone. You can lose some or all of your deposit, so only use money you can afford to lose. Read the full risk warning before you open an account.

What should you do next?

Before using real money, practise the mechanics with no financial risk to your own funds. Open a demo account, place a few long and short trades, and watch how the spread, margin and profit and loss figures change. Our guide to the demo account shows how to set one up.

Then decide how much you would be willing to lose on one trade before you place it, and choose a position size that matches. Small sizes while you learn are far kinder than large ones.