How CFDs Work

What Is a CFD?

A contract for difference (CFD) is a derivative that allows us to gain exposure to price movements without owning the underlying asset itself. The result of the trade is based on the difference between the opening and closing price, adjusted for the position size and applicable costs.

Long and Short Exposure

CFDs can generally provide both long and short exposure. This makes them flexible for traders who want to speculate on rising or falling prices. However, the flexibility comes with specific risks because the underlying asset is not actually owned.

Leverage and Margin

CFDs commonly use margin and leverage. Margin is the amount of capital required to support the position, while leverage allows the position’s market exposure to be larger than the capital committed. This magnifies both gains and losses. A small adverse move can therefore have a large effect on the capital allocated to the trade.

Costs Matter

We must consider the spread, commissions where applicable, and financing costs. Holding a leveraged CFD overnight can create financing charges. These costs can materially change the outcome of a swing trade even when the price movement itself was favorable.

Practical Example

Suppose we open a leveraged CFD position representing $10,000 of market exposure while only a fraction of that amount is posted as margin. A 2% move in the underlying changes the gross position value by about $200 before costs. The important point is that the gain or loss is measured against the full exposure, not merely the margin deposit.

Trader Application

Before using a CFD, we identify the underlying, leverage, margin requirement, spread, financing rules and liquidation conditions. We do not treat the margin amount as the same thing as our economic exposure.

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