Cfd trading
Family X · Account mechanics
Not to be confused with cfd, cfd analysis, cfd broker.
CFD trading is the act of opening and closing contracts for difference, derivative positions that settle in cash against the movement of an underlying asset rather than through delivery of that asset. The trader posts margin and is exposed to the full notional movement of the position, so both gains and losses are magnified relative to the capital committed. The activity is a way of speculating on or hedging price changes in shares, indices, currencies, commodities or cryptoassets.
Mechanics of a position
Every CFD trade has two sides: the price at which the position is opened and the price at which it is closed. The contract pays the difference, multiplied by the position size, in the account's base currency. Because no asset changes hands, there is no settlement or delivery; the position is marked to market and the resulting profit or loss is credited or debited.
Margin is the collateral that must be held against the notional exposure. It is set as a percentage of position value, and the percentage varies by asset class, by the venue, and by the retail or professional classification of the client. A margin requirement of 5% corresponds to leverage of 20:1; a requirement of 20% corresponds to 5:1.
Financing is charged or paid on leveraged positions held overnight, calculated from a reference interest rate plus or minus a spread set by the provider. Long positions typically pay financing; short positions may receive it, depending on rates.
Worked example
A trader buys one CFD on a share index at 4,000 points with a position size of £10 per point and a margin requirement of 5%.
The £500 gain is 25% of the £2,000 margin, while the index itself moved 1.25%. A 50-point fall would produce a £500 loss on the same margin. Financing and any spread are additional costs not shown above.
Costs and risks
Costs include the spread between bid and offer, commission on some markets, overnight financing, and currency conversion where the asset is denominated in another currency. These charges accrue whether or not the position is profitable.
Leverage cuts both ways. A move equal to the margin requirement wipes out the posted collateral, and a larger adverse move can produce a loss exceeding the deposit, creating a debt to the provider. Many jurisdictions require retail clients to hold minimum margin levels and offer negative balance protection, but the rules differ by country and by firm, so the applicable terms must be checked with the specific provider and regulator.
Where it is used
CFD trading is available in the UK, Europe, Australia and parts of Asia, while it is restricted or prohibited for retail clients in several other jurisdictions, including the United States. Access, leverage caps, marketing rules and compensation arrangements therefore vary by the client's country of residence and the regulatory status of the firm.
Often confused with
- cfd
- A CFD is the contract itself, a single derivative instrument, whereas CFD trading is the activity of buying and selling such contracts; the visible sign is that one names an instrument and the other names a practice.
- cfd analysis
- CFD analysis is the study of price data, indicators and market conditions to inform decisions, whereas CFD trading is the execution of positions; the visible sign is that analysis produces a view and trading produces a fill.
- cfd broker
- A CFD broker is the firm that provides the venue, prices and margin facilities, whereas CFD trading is what the client does on that venue; the visible sign is that one is an entity and the other is an activity.