Contract for Differences CFD Definition and How It Works

Ongoing learning is essential if you want to become an expert trader. Here at CAPEX, we offer several learning tools and features to ensure our traders prosper in their trading journeys. For instance, we offer CAPEX Academy, an online trading school for traders to learn the basics of trading through videos. We also offer a trading dictionary and expert trading blog so traders can understand important terminologies and remain up-to-date with ongoing market trends.

  • At this point, a CFD provider can require additional margin payments or close contracts at inferior prices.
  • While leverage can amplify potential gains, it also increases the risk of losses if the market moves against a trader’s position.
  • The first trade constructs the open position, which is later closed out through a reverse trade with the broker at a different price.
  • Some financial commentators and regulators have expressed concern about the way that CFDs are marketed at new and inexperienced traders by the CFD providers.

Contracts for difference are financial derivative products that allow traders to speculate on short-term price movements. Some of the benefits of CFD trading are that you can trade on margin, and you can go short (sell) if you think prices will go down or go long (buy) if you think prices will rise. CFDs have many advantages and are tax efficient in the UK, meaning that there is no stamp duty to pay. Please note, tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.

How confident are you in your long term financial plan?

A Contract for Difference (CFD) is a financial derivative that allows traders to speculate on the price movement of an underlying asset, such as stocks, commodities, indices, or currencies. CFD trading requires a good understanding of financial markets along with an apprehension for risk-taking. Given the risk of significant financial losses, it may not be suitable for all traders or investors, especially those who are risk-averse or beginners in financial markets. Always consider your risk tolerance and financial abilities before engaging in such trading. CFD trading provides higher leverage than traditional trading, allowing traders to enter a larger position than their account’s value would typically permit.

definition of contract for difference (CFD) trading

Leveraged trading is at times referred to as ‘trading on margin’ since the margin – the budget required to open and maintain a position – represents only a fraction of its total size. The investor buys 100 shares of the SPY for $250 per share for a $25,000 position from which only 5% or $1,250 cfd liquidity providers is paid initially to the broker. An investor wants to buy a CFD on the SPDR S&P 500 (SPY), which is an exchange traded fund that tracks the S&P 500 Index. We introduce people to the world of trading currencies, both fiat and crypto, through our non-drowsy educational content and tools.

Ability to Profit From Both Rising and Falling Markets

You can also use CFD trades to hedge an existing physical portfolio. With a CFD trading account, our clients can choose between holding positions in the long-term and quick day trading​ strategies. The meaning of CFD is ‘contract for difference’, which is a contract between an investor and an investment bank or spread betting firm, usually in the short-term. At the end of the contract, the parties exchange the difference between the opening and closing prices of a specified financial instrument, which can include forex, shares and commodities. Trading CFDs means that you can either make a profit or loss, depending on which direction your chosen asset moves in. This means that with a small initial investment, there is potential for returns equivalent to that of the underlying market or asset.

definition of contract for difference (CFD) trading

This magnifies potential gains but also amplifies potential losses. Additionally, CFD trading is typically conducted on a margin basis, which means that traders only need to deposit a small percentage of the full value of the position to open a trade. The primary objective of CFD trading is to speculate on price movements and potentially profit from them. Traders use CFDs for various reasons, including portfolio diversification, short-term trading opportunities, and hedging existing positions. Having a smooth trading platform that is easy to use makes trading a lot easier. Here at CAPEX, we offer traders two trading platforms – The CAPEX WebTrader & MT5 Trader, both of which are user-friendly in all aspects.

What is the main difference between stock trading and trading CFDs?

You may also consider guaranteed stop losses, which provide greater security in more volatile markets, but also require a fee to use. Similarly, you can place stop-losses to mitigate CFD risks and restrict potential losses. A stop-loss is triggered at the level indicated priorly by a trader and will be executed at the next available price quotes. Note, however, that in case of volatile markets, lack of liquidity or big orders sizes can result in slippage. A guaranteed stop loss can protect against slippage, yet it comes at a fee. When you open a CFD position, you select the number of contracts you would like to trade (buy or sell).

Also, if money is borrowed from a broker to trade, the trader will be charged a daily interest rate amount. Unlike stocks, bonds, and other financial instruments where traders must physically own the securities, CFD’s traders don’t hold any tangible asset. Instead, they trade on margin with units that are attached to a given security’s price depending on the market value of the security in question. A CDF is a contract made in financial derivatives trading between you and the broker to exchange the difference in the price of a financial product.


In addition, Vietnam’s emerging market economy provides unique investment opportunities, making it an attractive destination for traders in differential contracts. If the underlying asset’s price increases, the buyer profits from the price difference, and if the price decreases, the seller profits. CFD trading provides access to a broad range of financial instruments, including stocks, indices, commodities, currencies, and even cryptocurrencies. As mentioned earlier, one of the primary advantages of CFD trading is the ability to profit from both rising and falling markets. This flexibility allows traders to capitalize on diverse market conditions and implement a wide range of trading strategies. As the name suggests, day traders open and close trades over the course of the day, usually holding positions for only a few hours.

Since there is no ownership of the underlying asset, there is no borrowing or shorting cost. Brokers make money from the trader paying the spread meaning the trader pays the ask price when buying, and takes the bid price when selling or shorting. The brokers take a piece or spread on each bid and ask price that they quote.

Lower Transaction Costs Compared to Traditional Trading Methods

Instinctively, this would be an obvious investment for any trader. Unfortunately, margin trades can not only magnify profits but losses as well. The meaning of CFD is ‘contract for difference’, which is a contract between an investor and an investment bank, usually in the short-term. With CFD trading, you don’t buy or sell the underlying asset (for example a physical share, currency pair or commodity).

It’s best to thoroughly educate yourself on how leverage and margin work before trading. If you think the price of an asset will fall, you would open a short (sell) position, profiting if it falls in line with your prediction. However, once again, you would be risking making a loss if you were mistaken. Holding costs – These are charges over the open positions a trader may incur at the end of the trading day. They are positive or negative charges depending on the direction of the spread. The investor would purchase 1,000 CFDs at the ask price of $10.00 to open a $10,000 CFD buy or “long” trade because they believe the price is going to rise.

Disadvantages of a CFD

Day trading removes the risk that occurs when you leave a position open overnight. With regards to tax, there is no stamp duty to pay on CFDs since the underlying asset isn’t owned. Overall, tax represents one of the areas that CFDs save traders costs compared to traditional trading. Online CFD providers opened the door to a host of new possibilities for traders, including adding derivatives to their portfolio. Today the London School of Economics estimates that CFD trading accounts for more than a third of all stock market trades in the UK. By not owning the underlying asset, CFD traders can avoid some of the disadvantages and costs of traditional trading.

Calculate your potential risks and profits with our easy-to-use calculators. The value of a unit of the CFD you’re trading will depend upon the instrument, so you should calculate the number of CFD units that can work best with your trading strategy. For that reason, FXTM has created a guide to CFDs, answering the big question, ‘what is CFD trading? For every point the price of the instrument moves in your favour, you gain multiples of the number of CFD units you have bought or sold. You’ll be able to monitor open positions on the platform and close them when you want. Due to his keen analysis, he’s confident that the prices will rise by a margin of 12% per barrel in the next year.

Fees and charges of CFDs

It is essential to choose a well-regulated and reputable broker to mitigate this risk. Some key features of CFDs include the use of leverage, which allows traders to control a larger position with a smaller initial investment. Beginning your trading journey is an overwhelming experience to begin with, so trading on a platform that isn’t easy to understand or use can lead to a poor trading experience.