What Is a CFD?

A contract for difference, or CFD, is an agreement between you and a broker to exchange the difference in an asset's price between when you open the contract and when you close it. You never own the underlying share, currency or commodity. If the price moves in your favour, the broker pays you the difference; if it moves against you, you pay the broker.

How a CFD trade works#

You can open a CFD to profit from a rise (going long) or a fall (going short) just as easily. Many brokers offer CFDs on thousands of shares, indexes, currencies, commodities and cryptocurrencies from one account.

Costs of trading CFDs#

• Spread: the broker quotes a buy and a sell price; the gap is a cost on every trade.
• Commission: charged on share CFDs at some brokers.
• Overnight financing: a long position held past the daily cut off is charged interest on the full exposure, not just the margin. Short positions may receive or pay a smaller amount. Over weeks or months this adds up. See Financing and Overnight Costs.
• Other fees: currency conversion and, at some brokers, inactivity fees.

Where CFDs are allowed#

CFDs are popular in the UK, Europe, Australia and many other countries. They are not permitted for retail traders in the United States, where similar exposure is gained through listed futures, options and ETFs instead.

In the European Union and the UK, regulators restricted retail CFDs in 2018. The rules include:

Brokers must also close positions when margin falls to half of the required level, protect retail clients from losing more than their deposit, and publish the percentage of retail accounts that lose money. Those published figures are usually well above half, which tells you how hard short term leveraged trading is.

CFDs vs owning the asset#

Risks#

• Leverage: losses grow as fast as gains, and margin calls can close positions at the worst moment.
• Counterparty risk: your contract is with the broker, so the broker's financial strength and regulation matter. See How to Choose a Broker.
• Gaps: prices can open far from the previous close, skipping your stop.
• Financing drag: long term CFD holdings are usually expensive compared with owning the asset.

Frequently asked questions#

Can you lose more than you invest with CFDs?#

Under UK and EU retail rules, brokers must provide negative balance protection, so retail clients cannot lose more than their account balance. Elsewhere, and for professional clients, losses can exceed deposits.

Why can US residents not trade CFDs?#

US rules on over the counter derivatives effectively prohibit offering CFDs to retail customers, so regulated US brokers do not provide them.

Are CFDs good for long term investing?#

Usually not, because daily financing costs on the full position size add up over time. They are mainly used for short term trading and hedging.

Sources#

• European Securities and Markets Authority, Product intervention measures on CFDs
• Wikipedia, Contract for difference