CFD trading: complete guide

A contract for difference (CFD) is a derivative that lets you speculate on changes in the price of an underlying asset without owning the asset itself. CFDs let you take a long (buy) or short (sell) position on stock indices (S&P 500, Nasdaq 100, DAX 40), stocks, commodities (gold, oil) and currency pairs.

CFDs are leveraged products: an initial outlay, the margin, gives you exposure to a larger amount. This feature amplifies potential gains but also losses. CFDs are not available to retail clients in every country: in the United States, for example, they cannot be offered to retail investors.

A CFD tracks the price of an asset without you owning it. You choose a direction (buy if you expect a rise, sell if you expect a fall) and a position size, then close the position whenever you want. Your gain or loss is the price difference multiplied by the position size, minus fees.

Example: you buy 10 CFDs on a stock priced at $100, for an exposure of $1,000. With a 20% margin, you tie up $200. If the stock rises to $110, your gross gain is $100, or 50% of the margin committed. If it falls to $90, you lose $100, half of your margin, plus the spread and any financing fees.

Buying a stock makes you a part-owner of the company: you receive dividends, you can vote at meetings and you can hold the shares for as long as you like with no holding costs. With a CFD, you own nothing: the broker pays or charges you an adjustment equivalent to the dividend, and you have no voting rights.

On the other hand, a CFD makes short selling simple and lets you use leverage. CFD positions carry daily financing fees, which makes them better suited to short horizons than to a multi-year investment.

In the United Kingdom, the European Union and Australia, regulators (the FCA, ESMA through national regulators such as CySEC, and ASIC) have imposed strict rules on CFDs for retail clients: leverage limits from 30:1 on major currency pairs down to 2:1 on cryptocurrencies, margin close-out rules, mandatory negative balance protection and a standardized risk warning showing the percentage of retail accounts that lose money.

Outside these jurisdictions, brokers often serve clients through offshore entities with higher leverage and fewer protections. In the United States, CFDs cannot be offered to retail clients at all. The entity that opens your account therefore determines the rules that protect you.

Five criteria help you compare CFD brokers.

1. Regulation and investor protection. Check which entity will hold your account, its regulator, and whether negative balance protection and a compensation scheme apply.
2. Instruments offered. The number of indices, stocks and commodities varies widely from one broker to another: from a few hundred to tens of thousands of instruments.
3. Spreads and financing fees. Compare the spread on the instruments you are targeting and the overnight financing fees, which weigh on positions held for several days.
4. Negative balance protection. It is mandatory for retail clients in the UK, the EU and Australia, but not everywhere. Without it, losses can exceed your deposit.
5. Platforms and customer support. MetaTrader, cTrader, TradingView or a proprietary platform depending on the broker; check that support is available in your language.

Trading CFDs involves a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. A modest change in the price of the asset can wipe out all the margin on a position. When the available margin becomes insufficient, the broker can automatically close your positions, often at the worst possible time.

CFDs also carry counterparty risk: your contract is entered into with the broker, not on an exchange. According to the risk warnings published by brokers in regulated jurisdictions, between 65% and 85% of retail accounts lose money when trading CFDs.