What Is a CFD and How Does CFD Trading Work?

What a contract for difference is

CFD stands for contract for difference. It is an agreement between you and your broker to settle the difference in an instrument’s price between the moment the position opens and the moment it closes. That difference is paid in cash, in your account currency.

The important half of that sentence is what is missing. You never own the instrument. Buy a gold CFD and no gold moves anywhere. Buy a US 500 CFD and you hold no shares in any of the companies in the index.

Several consequences follow from that.

There is nothing to deliver or store, so there is no settlement period and no custody. A share CFD carries no vote. Dividends on share and index CFDs arrive as a cash adjustment rather than a payment to an owner. And because nothing is borrowed in order to sell, opening a position that gains when the price falls is an ordinary order.

The words “buy” and “sell” are convention rather than description. Opening a long CFD means the contract settles in your favour if the price rises and against you if it falls. Opening a short reverses that. Nothing changes hands either way.

How a CFD trade works from open to close

The sequence is the same on every instrument.

1. You see a two-sided quote. Every instrument shows a lower bid, where you can sell, and a higher ask, where you can buy. The gap is the spread.

2. You choose a direction. Long if you expect the price to rise, short if you expect it to fall. Both take the same effort and both carry the same kind of risk. The differences that do exist are set out in going long vs going short.

3. You choose a size. CFD size is expressed in lots or contracts. Each instrument has a contract size that defines what one lot is worth per point of movement, and these are not comparable across instruments. One lot of a currency pair, one lot of gold and one lot of an index are three completely different amounts of exposure.

4. Margin is reserved. A portion of your balance is set aside to hold the position. It is not spent and not paid to anyone. Your free margin — the balance still available to open further positions or absorb losses — falls by that amount.

5. The position moves while it is open. Your balance stays unchanged until you close. What moves is your equity: balance plus or minus the unrealised result of open positions. Equity is the figure that matters while trades are running.

6. You close by taking the opposite trade. A long is closed by selling at the bid, a short by buying at the ask. The difference is settled and the margin is released.

There is a seventh step that happens without you. Brokers monitor your margin level, which is equity divided by the margin in use. If it falls below a set threshold, the platform starts closing positions automatically at a stop-out. That is not a warning. Positions close at whatever price is available, which in a fast move can be a long way from where you expected.

What you can trade as a CFD

CFDs exist across most liquid markets: currency pairs, spot metals such as XAU/USD (gold), stock indices such as the US 500, energies and individual shares.

The appeal is that they sit in one account, on one platform, drawing on one pool of margin. The danger is the same thing: instruments that look alike on a screen behave nothing alike.

Gold is quoted in dollars per ounce and typically sized at 100 ounces per lot. An index CFD moves in index points, has its own trading hours and its own daily break. A share CFD carries dividend adjustments and often a commission rather than a wide spread. A currency pair moves in pips against a contract of 100,000 units. Applying a position size that felt reasonable on EUR/USD to gold, without reading the contract size, is one of the most common and most expensive beginner errors. Forex specifically is covered in what forex trading is.

Before you size a trade on an instrument for the first time, read three figures: contract size, minimum volume, and margin requirement. All three are published per instrument on the CFD trading page.

Margin, leverage and why CFD losses scale

Margin is the deposit required to hold a position. It is quoted either as a percentage of position value or as a leverage ratio, and the two are the same statement. A 1% margin requirement is 1:100 leverage. A 2% requirement is 1:50.

At 1% margin, a position worth $100,000 requires $1,000 of your money to hold.

Here is the part that decides how much trouble an account gets into. Leverage does not change what one point of movement is worth on your position; contract size and lot size set that. It changes how large a position you are allowed to open with the money you have, and therefore how little of your balance stands behind each point.

Two further mechanics catch beginners out.

Margin is reserved, not risked in a capped way. The loss on a position tracks the full position value, not the margin set aside for it. A market move worth more than the margin does not stop at the margin.

And each new position consumes free margin, which makes every position you already hold more fragile. Open a second trade and the first one now has less equity cushioning it before the margin level reaches the stop-out threshold. Positions are not independent of each other; they share one account.

What CFD trading costs

CFDs are cheap to open and expensive to sit in. Five costs apply.

Spread. Paid at the moment you open, on every position, in both directions. A position that has not moved is behind by the spread.

Commission. Charged per lot on some instruments and account types, usually in exchange for a tighter spread.

Overnight financing, or swap. Because you post only margin, the rest of the position is effectively financed, and that financing is charged or credited daily at rollover. One day a week it is applied at triple rate to cover the weekend. On a position held for weeks or months, financing is frequently the largest cost of the trade by a wide margin, and it is the one beginners forget to check.

Currency conversion. If the instrument settles in a currency other than your account currency, a conversion applies to the result.

Corporate action adjustments. On share and index CFDs, dividends and similar events are applied as cash adjustments, debited on short positions and credited on long ones.

The pattern worth internalising: CFD costs scale with how long you hold, not only with how often you trade.

Worked example: a gold CFD in both directions

Assume XAU/USD is quoted 2,400.20 / 2,400.60. You can sell at 2,400.20 and buy at 2,400.60, so the spread is 0.40 — forty cents per ounce. Treat that as typical and illustrative, not fixed.

Gold is sized at 100 ounces per lot, so one lot moves $100 for every $1 gold moves. You open 0.10 lots, which is 10 ounces. A $1 move in gold is therefore worth about $10 to you.

You buy at 2,400.60 while the sell price is 2,400.20. The position opens 0.40 behind, which on 10 ounces is about $4. That is the spread, paid before the market has moved.

The position is worth 10 × 2,400.60, or about $24,000. At 1% margin, roughly $240 of your balance is reserved to hold it.

Now the move. If gold falls $5 to 2,395.60, that is about $50 off your balance, plus the $4 spread already paid. A $5 move the other way is worth the same $50, in the other direction, less the spread. Held overnight, a financing charge or credit applies on top.

Set those two numbers side by side. The margin reserved is about $240. A $5 move in gold — a routine day — is worth about $50 of it. A $24 move, which gold has done inside a single session, is worth the entire $240. The margin is what it costs to open the position. It is not a limit on what the position can cost you.

Key takeaways

• A CFD settles the cash difference in an instrument’s price between opening and closing, so you hold a contract with your broker rather than the asset itself.
• Contract size differs completely between currency pairs, metals, indices and shares, so a position size that suits one instrument can be far too large on another.
• Margin is the deposit needed to open a position, not a ceiling on what it can cost, because losses track the full position value.
• Overnight financing is charged daily and is often the largest cost on a position held for more than a few days.

Frequently asked questions