Trading Defined
DerivativesIntermediate

Contract for DifferenceCFD

A contract for difference is an agreement with a broker to exchange the change in an asset's price, so you can trade it without owning it.

A CFD lets you trade the price of a share, index, currency, commodity or crypto asset without owning it. You and the provider agree to settle the difference between the opening and closing price; you post a margin deposit, and you can go long or short. CFDs are popular in Europe, the UK and Australia — and they are also where many retail traders lose money, which is why regulators restrict how they are sold. This entry explains how CFDs work, what they cost, and the rules that protect retail clients.

Category
Derivatives
Reading time
5 min
Also called
CFDs, CFD trading, Contracts for difference
Updated

A CFD in plain words

Buy a CFD on a stock at $100 and sell it at $108, and the provider pays you the $8 difference per share; if it falls to $95, you pay $5. You never own the shares, so you have no voting rights, but you can trade with leverage and go short easily.

Because CFDs are leveraged, small price moves have large effects on your deposit.1 See Leverage and Margin.

How a CFD trade works, step by step

  1. Choose the market and direction

    Buy (long) if you expect a rise, sell (short) if you expect a fall. See Long Position and Short Selling.

  2. Post margin

    The provider requires a deposit set by the leverage limit. For retail clients in the EU, ESMA set limits from 30:1 to 2:1 depending on the underlying.2

  3. Pay the spread

    Most CFD prices include a spread; some share CFDs charge a commission instead. See Bid-Ask Spread.

  4. Pay or receive overnight financing

    Positions held overnight usually incur a daily financing charge (or credit for some shorts). See Overnight Financing Fee.

  5. Watch the margin level

    Under ESMA’s rules for retail clients, providers must close positions when margin falls to a set level on a per-account basis.2

  6. Close the position

    Closing settles the difference between the opening and closing price, after costs.

Worked examples

Example 1 — A share CFD

Long

A trader buys a CFD on 200 shares at $50 ($10,000 exposure). Individual equities are limited to 5:1 leverage for EU retail clients, so margin is $2,000.2 The price rises to $54.

Example 1 — A share CFD — calculation
Gain200 × $4 = +$800
Return on margin+40%

An 8% move in the share produced a 40% return on the deposit — before costs. The same move down would cost 40%.

Example 2 — Financing over time

Financing

The same $10,000 position is held for 60 days with an annual financing rate of 7%.

Example 2 — Financing over time — calculation
Approximate financing$10,000 × 7% × 60 ÷ 365 ≈ $115
As % of the $800 gain≈ 14%

CFDs suit shorter holding periods; over months, financing can take a large share of the profit. Rates vary by provider.

Example 3 — A currency CFD at 30:1

30:1

A trader opens a €30,000 long EUR/USD position with €1,000 margin (30:1, the maximum for major pairs for EU retail clients).2 The euro falls 2% against the dollar.

Example 3 — A currency CFD at 30:1 — calculation
Loss€30,000 × 2% = −€600
As % of margin−60%

A 2% currency move erased most of the deposit. Negative balance protection means EU retail clients cannot lose more than the funds in their account.2

Figure 1

How leverage magnifies CFD results

How leverage multiplies the change in your own moneyThe horizontal axis is the price change from −25% to +25%; the vertical axis is the change in your own money. Without leverage a 10% fall costs 10%. At 2× it costs 20%, at 5× it costs 50%, and at 10× a 10% fall wipes out 100% of your money. At 5× a 20% fall does the same.-100%-50%+50%+100%0%-20%-10%+10%+20%Price changeChange in your own money1×2×5×: all of your money gone at -20%5×10×: all of your money gone at -10%10×
The same price move produces much larger gains and losses on your deposit at higher leverage.

ESMA leverage limits for retail CFD clients (2018)

AspectMaximum leverageMinimum margin
Major currency pairs30:12≈ 3.3%
Non-major pairs, gold, major indices20:125%
Other commodities, non-major indices10:1210%
Individual equities and others5:1220%
Cryptocurrencies2:1250%

Why traders use CFDs

  • Short selling

    Going short is as easy as going long, without borrowing shares. See Short Selling.

  • Access to many markets

    One account can trade indices, currencies, commodities and shares.

  • Hedging

    A short CFD can offset a fall in shares held elsewhere. See Hedging.

  • Capital efficiency

    Margin is a fraction of the exposure — with matching risk.

Advantages and disadvantages

Advantages

  • Easy long and short exposure to many markets.
  • No need to own or borrow the underlying asset.
  • Retail protections in many jurisdictions, including negative balance protection in the EU.

Disadvantages

  • Leverage magnifies losses; many retail accounts lose money.
  • Overnight financing makes long holding periods expensive.
  • You trade against or through the provider, so counterparty risk matters. See Counterparty Risk.
  • Not available to retail clients in some countries, including the United States.

Going deeper

Read as far as you need. Each level builds on the one before it.

Read the risk warning

Beginner

EU rules require CFD providers to show a standardised risk warning that includes the percentage of their retail accounts that lose money.2 That number is often well above half — read it before opening an account.

Retail protections

Intermediate

ESMA’s 2018 measures for retail clients combined leverage limits, a margin close-out rule and negative balance protection on a per-account basis, restrictions on incentives to trade, and the standardised risk warning.2 National regulators in Europe and the UK have since applied their own versions; check the rules where you live.

Pricing models and counterparty risk

Advanced

Some providers act as market maker and take the other side of client trades; others pass orders to the market (direct market access). Either way, your contract is with the provider, so its financial strength and how it handles client money matter.

Common mistakes

  1. Using maximum leverage

    The maximum allowed is not a recommendation. Size from your stop. See Position Sizing.

  2. Holding for months

    Financing costs add up; consider unleveraged shares for long holding periods.

  3. Ignoring weekend and overnight gaps

    Gaps can trigger margin close-out well beyond your stop. See Price Gap.

  4. Choosing a provider by bonus

    Incentives were restricted for a reason; look at regulation and costs instead.

Check your understanding

Test yourself before moving on. Each answer comes with an explanation.

Q1An EU retail client opens a $15,000 CFD on an individual share. What is the minimum margin under ESMA’s limits?
Q2What does negative balance protection do for retail CFD clients?

Key points to remember

  1. A CFD settles the difference between opening and closing prices without owning the asset.
  2. CFDs are leveraged: small moves have large effects on the deposit.
  3. EU retail limits range from 30:1 for major currencies to 2:1 for crypto.
  4. Spreads, commissions and overnight financing are the main costs.
  5. Read the provider’s risk warning and check its regulation.

Frequently asked questions

Can I trade CFDs in the United States?

CFDs are generally not available to retail clients in the US. US traders use alternatives such as futures, options or margin accounts.

Do I own the shares when I buy a share CFD?

No. You hold a contract with the provider that tracks the share price. You have no voting rights, though providers usually adjust for dividends.

Can I lose more than I deposit?

In the EU and UK, retail clients have negative balance protection, which limits losses to the funds in the account. Professional clients and clients in other countries may not have it.

Further learning

Sources

This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.

  1. IG. What are forex CFDs and how do you trade them? (opens in a new tab) Checked .
  2. European Securities and Markets Authority. ESMA adopts final product intervention measures on CFDs and binary options (June 2018) (opens in a new tab) Checked .

Read more elsewhere

Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.