What is a CFD? Explanation, worked example and risks

A CFD (contract for difference) is a contract between you and a broker on the price difference of an underlying asset. That can be a currency pair, but also a stock index, commodity, share or cryptocurrency. You don't own the underlying asset: you only gain or lose the difference between the price when you open and when you close your position.

How a CFD works

• Buying (long): you expect the price to rise. If it rises you make a profit; if it falls you make a loss.
• Selling (short): you expect the price to fall. With a CFD you can trade a fall just as easily as a rise.
• Leverage: you only put up part of the position value as collateral, the margin. The broker effectively lends you the rest. As a result, price moves have a much bigger impact on your deposit.

Worked example

You buy CFDs on a share priced at €100, for a position value of €5,000. Retail clients can use a maximum leverage of 1:5 on shares, so you set aside €1,000 in margin.

Price move	Result	Effect on your margin
+4% (to €104)	+€200	+20%
−4% (to €96)	−€200	−20%
−20% (to €80)	−€1,000	−100%

Costs such as spread, commission and financing are not included here. They always reduce your result.

What does a CFD cost?

1. Spread: the difference between the buy and sell price, paid on every trade.
2. Commission: some brokers charge a fixed fee per trade, especially on share CFDs or accounts with tight spreads.
3. Financing: if you hold a position overnight, you pay interest on the position value. On longer trades this adds up.
4. Other fees: inactivity fees, withdrawal fees and currency conversion costs.

Read more in Spreads, commissions and swaps.

CFD or real shares?

	CFD	Real share
Ownership	No, only a contract	Yes
Leverage	Yes, max. 1:5 for retail clients	No
Going short	Easy	Limited
Financing costs	Yes, per night	No
Dividends	Usually a cash adjustment	Yes
Suitable for the long term	Usually not	Yes

CFDs are mainly designed for short-term trading. Long-term investors usually choose real shares or ETFs.

Why do most retail traders lose money?

Brokers with a European licence must publish what share of their retail accounts lose money. For almost every broker that is a clear majority. Leverage, the cost of frequent trading and emotional decisions all play a big part.

Protection in the EU

Retail clients in the EU are protected by fixed rules: maximum leverage per asset class, automatic close-out when your account value falls below 50% of the required margin, and negative balance protection: you cannot lose more than your account balance. Read more in Leverage and margin.

Practise first with a demo account and compare only regulated brokers.